Building a passive income is a popular financial goal. After all, who doesn’t love the idea of money materialising inside their bank account without having to lift a finger for it. And even a modest sum can positively impact an individual’s lifestyle.
Dividend shares are arguably one of the easiest ways to establish a secondary income stream. And while these come with certain risk factors, the barriers to entry are exceptionally low compared to alternative methods. Today, it’s possible to build an income portfolio with as little as £5 a day, or £35 a week. Here’s how.
Start saving
Buying and selling shares isn’t free. Most brokerage platforms charge a small transaction fee, and even commission-free services have hidden fees that eat into investor capital. Therefore, it’s wiser to let my money accumulate into a more meaningful lump sum.
Apart from reducing transaction fees, this approach provides a few additional advantages:
- Saving inside an interest-bearing savings account that pays out on a monthly basis gives me a slight boost to my capital.
- Establishes a new habit of systematically putting money aside each week.
- Gives me time to reflect on which income stocks are worthy of investment.
After two months, I’ll have around £280 to work with, which is more than enough to build a starting position within a dividend-paying company.
Invest in high-quality companies
Income investing is one of hundreds of strategies being used in the stock market. And volatility can easily sway investors off their chosen path, leading to painful mistakes. When it comes to building a passive income, the focus should be on the longevity of a company and its earnings.
Don’t forget dividends are funded by excess profits. So if a business can’t maintain its margins and sales, shareholder payouts may be quick to follow. With that in mind, it’s important to analyse prospective investments carefully.
A business with no discernible competitive advantage or unique product/service will likely struggle to protect or steal market share. And in the long run, that eventually translates into shrinking profits, dragging both dividends and share price down.
The balance sheet also requires some attention. A thriving enterprise may struggle to stay afloat if the burden of debt is too high. After nearly a decade of near-free money, even FTSE 100 companies have become overly reliant on cheap debt financing. Now that interest rates have gone through the roof, profitability for many leading firms is coming under pressure.
How much can I make?
Realistically, £35 a week isn’t a large amount of money. But by capitalising on the power of compounding, that can change in the long run. Typically, UK shares generate an average return of around 8% each year when looking at the FTSE 100. And 4% of this stems from dividends.
Consistently investing £5 a day at this rate for 35 years would translate into a portfolio worth roughly £321,144. At a 4% dividend rate, that’s a passive income of £12,850. Of course, these returns aren’t guaranteed. Historical performance may not repeat itself, and gains may be lower or higher.
Nevertheless, earning a extra potential 13 grand a year is nothing to scoff at, and could pave the way to a far more comfortable retirement. That’s why I think the risk is worth taking.
