One method investors could use to target financial freedom is to build sources of passive income. And earning money without spending time and effort sounds highly appealing.
There are multiple ways to achieve this, but one of my favourites is by investing in dividend shares.
Once I’ve done the initial work of deciding which shares to invest in, it can be a relatively hands-off approach. It’s certainly far less work compared with passive income from buy-to-let properties, in my opinion.
That said, I’d still need to do some homework to pick some suitable dividend-paying shares.
Passive income from shares
First, I’d start by looking at the FTSE 100. This large-cap index currently offers a dividend yield of around 3.5%. This doesn’t sound appealing in the current climate. But as it’s just an average, there are several Footsie shares that offer much more.
For instance, over a dozen stocks offer at least 6% a year. I’d focus my search within this group. I wouldn’t buy all these shares though. That’s because many investment platforms charge a transaction fee.
By buying and selling shares frequently, all these fees would add up and can ultimately reduce the amount of passive income I receive.
So to minimise transaction costs, I’d pick three or four top picks and split my £10,000 equally between them.
Things to consider
Dividend yield isn’t the only thing to consider. I’d look at a range of other points, including dividend history, affordability, and growth potential.
A company that has been distributing income to shareholders for over a decade could be a more reliable passive income option than one that has just recently started.
Dividends are commonly paid from a company’s earnings. I look for a dividend cover of at least 1.5 to ensure it’s sufficiently affordable.
Lastly, I prefer to invest in businesses that offer earnings growth. If they can grow profits, there’s a chance that some of the gains result in larger dividends over time.
Top dividend shares
Some shares that meet my criteria right now include Phoenix Group, Legal & General, British American Tobacco and Rio Tinto.
This group of shares offer a yield of 7.1%, a dividend cover of 1.6, and 21 years of consecutive payment history. In addition, they operate in different industries. By buying all four, I’d avoid putting all my eggs in one basket.
If I had £10,000 to put towards a long-term passive income plan, I’d buy all four of these dividend shares today. I’d expect to receive around £710 a year in income.
A tasty bonus
Some companies also distribute special dividends to shareholders. These are often one-off payments from excess cashflow. It’s not guaranteed but can give investors a nice bonus.
On that note, bear in mind that even regular dividends aren’t guaranteed. If earnings take an unexpected tumble, dividends can be cut or suspended.
Also consider that passive income shares are often slow-growing, mature and established companies. The result of this can be limited share price gains.
My selection isn’t a fast-growing, high-octane bunch of shares. But I reckon they’ll provide me with a chunky and reliable dividend for years to come.
