Earning some more money each month does not necessarily mean having to work harder. A lot of people have some sort of passive income stream, such as renting out property. My own approach to generating extra income is to invest in shares that pay me dividends.
Here is how I can go about trying and target an extra £500 of earnings each month, on average.
Start with the end in sight
To do that, I will need to invest some money. But before getting onto that, I think it is helpful to work backwards from my ultimate objective here.
If I want to earn income in the form of dividends, I will need to own shares that pay me those dividends in future. I could try buying shares with a strong dividend record, but the past is not a guide to the future. So instead, I would focus on the question of what sorts of companies might pay me dividends.
Dividend shares to buy
Dividends are basically a way for a company to use spare cash it does not need in its business. So I would want to invest in certain types of business.
First, I would consider whether a firm’s market looks likely to stay strong and if it enjoys some some competitive advantage in it. For example, I expect resilient demand for electricity distribution. National Grid owns a network no rival can build from scratch.
Secondly, I would consider other possible demands on the company’s cash flows. For example, Vodafone generates a lot of cash, but it also has sizeable debts. Servicing them could eat into its ability or willingness to pay dividends.
Speaking of willingness, I also consider a company’s policy on paying dividends. Some firms like Games Workshop explicitly try to pay out spare cash to shareholders. Others such as Google parent Alphabet hoard it.
Targeting £500 in monthly extra income
I then consider a share’s valuation before buying it. Even a great company can make for a bad investment if I pay too much for it.
The price at which I buy a share also affects the dividend yield I receive. For example, I think instrument maker Judges Scientific ticks some of the boxes above. But its current share price means the yield is a measly 0.9%. To generate £500 in monthly dividend income from shares with an average yield of 0.9%, I would need to invest over £600,000.
I could hit my target investing less than that if the average yield of my portfolio was higher. I say “average” because I would always diversify my portfolio across a range of shares to reduce my risk if some perform poorly.
If I hit an average yield of, say, 7%, I could reach my target investing less than £86,000. If I have no cash to start, I could build up my extra income gradually by drip-feeding money regularly into a share-dealing account or Stocks and Shares ISA.
But I would be careful not to let the tail wag the dog. I am not simply hunting for high-yielding shares. I am looking for shares in great companies trading at an attractive price — that also offer me a good yield.
