Some extra money could usually come in handy for many. One way millions of people aim to earn extra cash on a regular basis is by investing in shares that pay them dividends.
I own some FTSE shares like M&G and British American Tobacco that pay me dividends of eight or nine pounds a year for each £100 I invested in them.
If I wanted to build a portfolio of FTSE shares to target monthly dividend income of £500, here is how I would go about it.
Blue-chip companies
First let me explain why I am focusing on FTSE companies.
Whether a FTSE 100 member or part of the FTSE 250 index of small- and medium-sized companies, these are businesses that have among the largest capitalisations on the London Stock Exchange. Household names such as Lloyds Bank, Tesco and Unilever are all FTSE 100 firms.
In itself, having a large market capitalisation is not a sign of quality. After all, a business can be overvalued relative to what it is really worth. But in general, I see many of the blue-chip companies that make up such indices as well-established enterprises with proven business models.
Of course, even a good company can run into bad times. So when investing, I reduce my risk by diversifying across a range of different shares.
Earning passive income
But not all FTSE shares pay dividends – and even those that do could stop at any moment. So how can I build my own portfolio based on strong prospects of future dividend income?
It can be tempting simply to look at companies that pay a large dividend relative to their current share price, a concept known as dividend yield. The danger with such an approach is that a business that sees its profits fall may cut its dividend.
Knowing what it paid before does not necessarily help me understand what will happen in future. Direct Line cancelled its previously juicy yield altogether this year, for example.
Instead, I look at whether a firm has an attractive business I think can generate substantial excess cash flows. For example, is it operating in an area with resilient, strong customer demand? Does it have some competitive advantage that can help set it apart in that field?
Aiming for my target
Yield is important when it comes to calculating my possible passive income from dividends, however.
If I want to target £500 per month on average, that is £6,000 in a year. Some FTSE shares have a fairly low yield, but I think in today’s market I could build a portfolio of blue-chip shares with an average yield of 5%. At that level, I would need to invest £120,000 to hit my dividend target.
One way to do that would be by putting a lump sum to work. But an alternative would be to start with an approach based on regular saving. I could put money aside weekly or monthly and build up to my target over time. I may suffer losses on the way of course, but I feel that my chances of achieving my goal are strong.
