The idea of doing something today that can earn me money in the future is attractive. But what if I could earn money – both now and in the future – without even working for it? That is the idea behind passive income.
I do not think it is as far-fetched as it may sound at first. After all, investing in shares that pay dividends is a proven source of income for millions of people already, including myself.
Here is how I would aim to start building passive income streams from scratch by putting aside just £5 a day.
Put a fiver aside come rain or shine
Saving that amount each day might not sound like an ambitious target. But with the end of the year in sight, other demands on my cash could make it tempting to take some time off saving.
I think the most reliable way to save however, is to get into it as a disciplined habit. So I would set a target I think I can achieve, based on my own financial circumstances. A fiver a day seems doable to me. I would then put that into a share-dealing account, or Stocks and Shares ISA every day, come rain or shine. This disciplined saving habit will form the foundation of my passive income plan.
Find winning income ideas
Some shares never pay out dividends. Others, like British American Tobacco and Diageo, have seen an annual dividend increase each year for decades. But some shares that have paid dividends in the past have had them cut, or canceled altogether.
With passive income as my objective, how should I try to find the sorts of shares that hopefully will pay me a steady or increasing flow of dividends over the years and decades to come?
I would hunt for companies with a proven business model and competitive advantage in an industry I expect to see robust customer demand. But I would also pay attention to a firm’s finances. Does it have funding needs that could restrict its freedom to pay out surplus cash as dividends?
Another aspect to consider is valuation. Even if a business is highly profitable, overpaying for shares in it could turn out to be an unrewarding investment. So I would want to consider a share’s valuation before buying it.
On top of that, the unexpected can always happen and dividends are never guaranteed. So I would reduce my risk by spreading the money across a diversified range of shares.
Lifelong passive income
My daily £5 would add up to over £1,800 in a year. If I invested that in shares with an average dividend yield of 5%, I ought to earn around £91 in annual passive income.
The following year, if I have not sold those shares and they maintain their dividends, I should get the same again. But with my ongoing saving, I could buy more shares that would generate further dividends.
In this way, as the years go by, hopefully I can build passive income streams that keep growing.
