I like the idea of earning more money without working for it. That concept is sometimes called passive income.
Rather than use some harebrained scheme to try and achieve that goal, my approach is to buy a portfolio of blue-chip shares I hope can pay me dividends in future. Here is how I could use such an approach over the long term to target annual dividend income of £5,000.
1. Get into a saving habit
To start investing, I need money. If I had a big enough lump sum, I could use that. But to earn £5,000 annually, if I invested in shares with a dividend yield of 5% (meaning they pay me 5p on the pound each year, based on my investment cost) that would take £100,000.
An alternative approach would be for me to drip-feed money regularly into a share-dealing account, or Stocks and Shares ISA. Getting into the habit of saving regularly, based on my own financial circumstances, could help me develop a healthy approach to building wealth in the long term.
2. Decide my investing strategy
Next, I would want to decide how to invest. With passive income as my goal, my focus would be on dividends. But not all dividends are equal!
For example, ought I to invest in a company with low dividend yield but high annual dividend growth, such as Judges Scientific? Or ought I plump for firms with a high yield, even if the growth rate is low, like Imperial Brands?
I would think about risk too. Part of my risk management approach would be only to invest in firms I understood and keep my portfolio diversified across a range of businesses. But I would want to make sure that all of my investment strategy matched my personal risk tolerance.
3. Find shares to buy
Having decided my strategy, I would then look for shares to buy that could help me earn passive income.
I would focus on finding great businesses with attractive share prices. I would be looking for firms I expected to generate large surplus profits they could divvy up among shareholders. So dividend potential is only part of what I consider.
If I just focus on dividends, I might walk into a ‘value trap’ – a share with a higher yield than its business can comfortably sustain. That can lead to a business cutting its payout (Imperial did just that several years ago).
4. Stay the course
I am an investor, not a speculator. This means having bought into what I think are excellent companies, I plan to hold their shares for the long term, rather than trading them frequently.
Sometimes, circumstances change and my investment thesis about a company may be affected. But, in general, I would stick with my plan, regularly putting money aside and building a portfolio of high-quality blue-chip shares.
5. Let the income roll in!
Doing that, I could sit back and, hopefully, see my extra income add up.
Putting aside £100 a week at an average yield of 5%, for example, my first year’s savings would hopefully earn me £260 in annual dividends. I should hit my £5,000 target in a couple of decades.
Over the years, if I keep saving and my portfolio grows, so should my passive income!
