The old saying is that money does not grow on trees. If it did, harvesting it would mean it was not really passive income! My own approach to passive income includes buying dividend shares.
That could help me generate free income, in the form of dividends. They could continue and indeed hopefully grow for the rest of my life.
Starting to do that does not even require a lot of money. If I had a spare £1,900 today, here is how I would go about it.
How dividend shares work
I describe dividends as free money because, once I buy a company’s shares, I am entitled to any dividends it pays while I hold them. I do not need to do anything other than buy the shares. I could keep earning such dividends for as long as I hold the shares, which could be the rest of my life (I am a long-term investor, after all).
Dividends are never guaranteed. So I would take time to really dig into shares and research them before buying to decide if they seemed right for me.
I would look for businesses I thought may well have the capacity and intention to pay dividends over the long term. Things like a unique competitive advantage, large target market, and willingness to pay out money to shareholders instead of spending it elsewhere would all be topics to consider when hunting for dividend shares.
Any share can disappoint, though. To protect against that risk, I would diversify my holdings across a variety of shares. With £1,900, I could comfortably invest in a handful of different firms.
An example in practice
I would follow famous investor Warren Buffett and stick to businesses I feel I understand.
An example is the brewer and distiller Diageo (LSE: DGE). Its business model of making and selling drinks is pretty straightforward. It can also be very lucrative, thanks to the company owning premium brands like Guinness.
As Diageo’s first-half results published today (30 January) showed, though a rough economy in some markets is hurting business, the firm is still a profit machine. Operating profit fell 11% compared to the prior-year period, but still comfortably topped $3bn.
Those risks continue and I also think the declining popularity of alcoholic drinks among many young people is a risk to revenues and profits at the business. But if I had spare cash to invest I would be happy to add it to my ISA.
The interim dividend grew 5%. Diageo is a Dividend Aristocrat, after delivering decades of continuous annual dividend increases.
Putting the plan into action
To do this, I would set up a share-dealing account or Stocks and Shares ISA, put the £1,900 in and look for dividend shares to buy.
Diageo yields 2.8%. Investing £1,900 at such a yield would earn me over £50 per year in passive income. But I would aim for a higher average yield (and therefore income) while still sticking to high-quality blue-chip shares.
