One of the approaches I use to try and earn passive income is buying shares I hope will pay me dividends.
Doing that, I think I could build substantial extra income streams over time.
As an example, if I had £8,000-£9,000 of savings I could spare, here is how I would try to target an average passive income of £360 each month.
Billions of pounds given away annually
Dividends are how a company shares its profits with shareholders.
That is not guaranteed to happen though. A business might not make profits. It might make them but decide not to pay a dividend, like Google parent Alphabet.
At any time, a business can reduce or cancel the payout. Direct Line abruptly axed its juicy payout this year.
But when it works, earning a passive income through owning dividend shares can work very well indeed.
After all, just a few FTSE 100 companies alone give billions of pounds every year to their shareholders as dividends. Hundreds of other publicly-listed shares also make shareholder payouts.
Choose brilliant shares and go to the beach!
Finding the sort of company that might spray me with free cash for years or decades to come is not as difficult as it may sound.
I would start by looking for businesses I expect to generate large free cash flows. Past performance is not a reliable indicator of what will happen next. So although I do look at a company’s track record, my main focus is on its commercial prospects down the line.
I try to avoid overpaying even for great shares. After all, if I earn dividends with one hand but see shares fall far below what I paid for them on the other, I risk ending up losing money, not making it.
With under £10,000 to invest, I would spread my money evenly over a few different shares to reduce the risk if one performs poorly.
Rather than rush to invest all the money at once, I would wait, however long it took to find what I thought were great shares selling at attractive prices.
Then I would sit back and relax, or go to the beach.
With the passive income machine humming profitably, I would only pay occasional attention to my portfolio, to assess whether the investment case for any of my picks had changed.
Goal in sight
With a monthly target of £360, I would be looking to earn £4,320 in passive income annually. I could do that if I earned an average dividend yield of 54%. No blue-chip share is going to pay me anything like that!
But, as a long-term investor, I could choose to initially reinvest dividends rather than take them out as cash. That is known as compounding.
If I could achieve an average dividend yield of 8%, for example, compounding £8,000 like that would let me hit my passive income target in 26 years.
Or, if my goal was more modest, I could choose not to compound and hopefully start earning passive income within months.
