People have all sorts of ideas about how to earn passive income. My own preferred approach involves buying shares in blue-chip companies then holding them for the long term.
The reason I like this approach is that it lets me benefit from the success of large businesses with proven expertise and knowledge in their fields. Unlike some passive income ideas, I do not need big sums of money upfront. In fact I can begin with nothing.
Here is an example of how I would put aside £200 each month with the aim of building towards a £500 monthly dividend income goal.
Regular saving
£200 a month is a big enough amount to help me move towards my target, but I also think it is realistic. Everyone’s financial circumstances are different. Adopting an unrealistic goal strikes me as pointless as I want to stick with my plan.
I would put the money into a share-dealing account, or Stocks and Shares ISA. Indeed, I see now as an ideal time to start as the current tax year’s deadline for contributions to my Stocks and Shares ISA falls in the coming week.
Buying shares for passive income
With the money I saved, I would buy shares I hoped may pay me dividends in future.
But not all shares pay dividends, even ones that have done so before. That helps explain why I would spread my money over a diversified range of businesses.
In choosing them, I would consider whether they looked likely to pay money to shareholders in future. For example, I consider whether the business operates in an area with high customer demand and also what specific competitive advantages it has that might help it do well. Such advantages may range from brands like the ones owned by Reckitt, to proprietary technology like AstraZeneca, or a unique piece of infrastructure as seen at National Grid.
I also then consider whether the company throws off a lot of spare cash it might distribute as dividends. Some firms keep money to fund growth or use it to service debt. So I always look at a firm’s balance sheet to see how much debt is on it.
Building towards my target
In today’s market, I think it would be realistic for me to aim for a 7% average annual dividend yield. Quite a few FTSE 100 firms have a yield at that level or higher, meaning if I invested £100 I would hopefully receive £7 in dividends each year.
If I invested £200 a month in that way, it would take me 36 years to reach my monthly target, though hopefully along the way my monthly dividend income would be increasing.
I could speed things up by reinvesting the dividends to boost my available investing funds, something known as compounding. Doing that at the same average annual yield of 7%, my monthly £200 contributions should see me earning £500 per month in passive income after 19 years.
