Investing in the stock market can be a great way to earn passive income. This involves owning shares in companies that distribute their earnings to shareholders as dividends.
I think that investing £500 per month for 30 years could result in a stock portfolio that could pay its owner £13,000 per year. Here’s how I’d do it.
Dividend shares
To earn £13,000 in annual passive income, I’d need to make 4% per year on my monthly investments. If I can do that consistently, I’ll reach my target after 30 years.
One way to do this is to buy shares with dividend yields above 4%. I can then use the dividends I receive to buy more shares, which means higher income in the future.
I believe this is highly achievable. In my view, there are some great businesses that fit the bill at the moment.
I’d start my portfolio with shares in Kraft Heinz. The company is part of Warren Buffett’s portfolio and generates steady cash flows for its investors.
Right now, the stock has a 4% dividend yield. On top of that, that the company is reducing its debt, so there might be scope for this to improve in future.
Diversification
As long-term shareholders of Kraft Heinz will know though, dividends are never guaranteed. In 2019, the company cut its dividend by 36%.
The company’s improving balance sheet means I don’t think it’s likely to do that again. But I feel it’s a good thing to diversify my investments to guard against that risk.
Over time, I could also add shares in AstraZeneca, HSBC, and Shell to my portfolio. Each of these currently has a dividend yield around 4%.
Doing this would mean that if anything went wrong at one of the businesses, I’d still receive most of my income in dividends from other sources.
The real key for me is to try and avoid companies where dividends are likely to be lower in the future. And that means sticking to those I can understand.
Compounding
Of course, there are stocks that have much higher dividend yields than 4%. Hargreaves Lansdown, for example, has a dividend yield closer to 5%.
Achieving a 5% annual return could yield £20,000 in annual passive income, rather than £12,000. That’s a big difference, but Hargreaves Lansdown stock looks risky to me.
The company pays out almost all its income as dividends and its earnings have been falling. That makes me think that the dividend might be lower in future.
Reinvesting my dividends is an important part of my plan. That’s why I’m looking for strong businesses whose shareholder distributions that are likely to prove durable.
If the stock market presents me with better opportunities in future, that’s great. But if not, I’d aim for a £13,000 second income by investing £500 per month.
