A lot of people reach a point in life where they could do with more income but do not have savings to invest. At that point, the right passive income ideas can come in very handy.
But I think some schemes to earn money without working for it seem more realistic than others.
That is why my approach to topping up my earnings involves investing in blue-chip shares I hope can pay me regular passive income in the form of dividends. Here is how I would aim to do that with no savings and a target of £3,600 a month in dividends.
Understanding dividends
When a company has surplus cash – for example because it makes a profit – it may decide to distribute it to shareholders in the form of a dividend.
Dividends, however, are never guaranteed. After all, a company may not make profits, or could decide to use them for something other than shareholder payouts.
But many big successful companies with proven business models do pay dividends. The likes of Guinness owner Diageo, Unilever and British American Tobacco have all been raising their annual payouts year after year for over a decade.
That does not mean they will continue to do so. But if I can build a diversified portfolio of high-quality businesses I think may well generate sizeable free cash flows for a long time to come, I reckon I could build up a sizeable passive income from dividends.
Finding shares to buy
Even well-known companies can cut their dividend, as Shell did in 2020 – or cancel them altogether like Direct Line did this year.
So how do I go about choosing shares I think may have big dividend potential?
I look to industries I feel I understand and try to find businesses with a big end market and some enduring competitive advantage. For Diageo, Unilever and British American Tobacco, I think proprietary brands can provide such an advantage.
I also look at a company’s balance sheet. Certainly, I would look to see if it had lot of debt that could swallow up cash flows that might otherwise be used to fund dividends.
Working towards a target
How realistic is my target of £3,600 each month on average?
My passive income will depend on how much I invest and the average dividend yield of my portfolio. At a 5% yield, a monthly £3,600 income would require me to invest £864,000. If I can earn an average yield of 10%, I could hit my target investing only half that much, £432,000 a month.
With no savings when starting, that might not seem realistic. The good news is that I could build up to that amount over time. If I invest £1,000 a month and reinvest my dividends, at an average yield of 10% I could hit my target within 16 years.
Some blue-chip FTSE 100 shares offer a double-digit yield, but not many. My first principle would be to buy into great quality companies when their shares are attractively priced. I never invest purely because of a high yield. After all, dividends can always be cut.
But I do believe that if I take a disciplined approach to putting aside money regularly and hunt carefully for the right shares, over time I could hit my £3,600 monthly passive income target.
