There are two ways to earn income: actively and passively. Passive income streams are those I can generate without working for them, like earning dividends on shares.
Unlike some passive income ideas, I could start to buy shares without a lump sum upfront, by saving regularly. In three steps, here is how I would go about that.
Step 1: allocate money to invest
The amount of passive income I generate from this plan would depend on two factors: how much I can invest and what I do with it.
I could start with a lump sum if I had one. But even if I did not have two brass farthings to rub together, I would try to start putting aside what I could afford on a regular basis. To do that I would set a target that was realistic for my own financial circumstances. That could be £1,000 a month — or £10. The more I invested, the higher my passive income potential, but anything would be a start!
Putting the money regularly into a share-dealing account or Stocks and Shares ISA, I would begin to build up the funds to invest. Meanwhile, I would learn more about shares and the stock market in general as I got ready to start investing.
Step 2: start buying shares
To earn dividends, I would need to use the money to buy shares.
How could I choose? Not all shares pay dividends. Even companies that do pay them can stop at any time. So I would focus on whether I thought a given share looked like good value for my money based on the likelihood of it paying dividends in future.
I would look for firms with a sustainable competitive edge in an industry I expect to benefit from resilient customer demand. For example, I think people will continue to buy cars for decades to come. Sales platform Auto Trader has critical mass and as it attracts more sellers, its usefulness increases for buyers. Its well-known brand and strong market position give it a competitive advantage.
But just buying into a good business might not be enough to start earning me passive income. I would want to focus on shares trading at what I thought was an attractive price — and with a good dividend yield.
Step 3: let the passive income roll in!
Dividend yield is the predictor of how much income I can hope to earn each year. Auto Trader yields only 1.5%, meaning for every £100 I invested I would hopefully earn £1.50 in dividends each year.
I think I could earn a higher yield while still focusing on quality companies. With a portfolio yielding 5%, for example, I would need to invest £72,000 to hit my target of £300 in average monthly passive income. What if I saved regularly instead of starting with a lump sum? I could still earn dividends — but it could take years for me to build up to my target gradually.
Either way, I would aim to buy a range of great shares at a good price with an attractive yield. Hopefully I would then see the passive income start to mount up.
