When it comes to generating passive income, I think buying dividend shares can have a lot going for it. Doing as such lets me benefit from the success of well-established companies with proven business models.
If I take a long-term approach to investing, I could seek to turn some of my savings into passive income streams long into the future. Here is an example of how I might aim to go about this by using a lump sum of £8,000.
Buying dividend shares to generate income
Some shares pay dividends, but not all do. Even those that pay out now may not do so in future, as dividends can often be cancelled.
So rather than just looking at the dividend yield offered by a company today, I focus on its underlying business prospects.
Does it have a competitive advantage in an industry that is likely to experience strong demand in the future? How well does the share price reflect that?
In terms of generating passive income, the dividend yield also matters. But I only tend to consider it after first filtering out shares based on these considerations.
Putting the theory into practice
As an example, in my portfolio at the moment I own financial services provider Legal & General. The company has a well-known name and an umbrella logo that helps to attract customers. It also benefits from a large base of existing clients and resilient long-term market demand.
At the moment, L&G shares offer investors a dividend yield of 8.8%. However, that might not last. Dividends are never guaranteed, after all. The firm could cut its dividend in the face of a market crisis scaring off investors, as it did in 2008.
For now however, I find the yield attractive. I am also excited by the long-term business prospects for the company.
Aiming for a long-term target
However, because even the highest quality shares carry risks, I would invest my money in a diversified portfolio of shares.
How could doing that help me try and hit my target of £500 a month from £8,000 of savings? The answer is down to the concept of compounding, which means reinvesting my dividends into buying yet more shares.
If I invested £8,000 in shares with an average yield of 8% and compounded the dividends, then after 30 years I ought to have a portfolio throwing off over £500 a month on average in dividends. That would mean I could hit my passive income target.
As I said above, this is clearly a long-term approach. But I think putting some spare money to work now to try and generate passive income streams could be a good use of both my time and effort!
