The idea of generating extra money without additional work appeals to me. Yet not all passive income ideas are really passive. That is why I like investing in income shares. I can simply sit back and earn dividends while companies like BP or Vodafone do the hard work of earning money for me!
Here is how that can work in practice. In this example I consider how I could aim to build an average monthly extra income of £700.
Starting with a target in mind
Beginning with a target can help me design a passive income plan that suits my investment objectives.
If I want to target £700 in monthly average dividends, I will need to receive around £8,400 per year of shareholder payouts. Dividends are never guaranteed, but a company’s prospective dividend yield expresses its expected annual dividend as a percentage of the current share price. So if I invested £84,000 at an average 10% yield, I should be able to hit my target. At an average 5% yield, I would need to invest £168,000.
Building a plan
That immediately raises a couple of questions.
First, what if I do not have anything like that much money to invest in income shares today?
I could still earn money from dividends, but it does mean it will take me longer to build up to my target. Instead of investing £84,000 as a lump sum, for example, I could build up to it by putting £500 each month into a share-dealing account or Stocks and Shares ISA. After 14 years I would already have put aside £84,000 even before considering the contribution of any dividends I had received, which might speed things up. As I grow my savings and invest them, I could hopefully earn some dividends regularly while building up to the £700 target.
The second question I think this example raises is: should I make my investment choices based on the highest yield I can get?
That can seem tempting – but I think it is a bad idea.
As I said above, dividends are never guaranteed. So the yield seemingly offered today by some income shares may not turn out to be what I earn if I buy them. Persimmon, for example, has a 17.5% yield based on its historical dividends. But this month the housebuilder announced a change in dividend policy that means future dividends will likely be lower.
Finding income shares to buy
Instead, I start by looking for companies I can understand that I think have excellent long-term commercial prospects. Only once I have decided I like both the business outlook and share price do I consider a firm’s dividend yield.
If I find good income shares to buy at an attractive price, hopefully over time my dividend streams will grow. Depending on how much I invest, it may take me years to hit my monthly target of £700. But with a clear objective and plan of how I aim to get there, hopefully I will reach it at some point. But I have to remember that returns are not guaranteed. Meanwhile, even if I do not yet earn £700 in dividends per month, I should still receive a growing amount by putting some more money to work in the stock market each month.
