Buying shares in well-known, successful companies that pay dividends is one way to try and earn passive income.
To do that I do not even need money saved up. I can match my efforts to my own financial resources. The passive income may also be substantial, if I take a long-term approach to investing and choose the right shares.
By putting £201 a month into the stock market, I think I could target a £48,758 annual income in future. Here are the steps I would take, starting now.
Save regularly
My first move would be to set up a share-dealing account or Stocks and Shares ISA. I would then start to put the £201 into it each month. Over time, financial circumstances can change so I would vary my regular contributions as needs be.
But I think getting into the habit of disciplined saving is important when developing the sort of long-term investment approach I hope could help me earn large passive income streams in future.
Building future dividend streams
What about that figure of £48,758, though?
To get to that, I presume a few things. First, I am using a 35-year timeframe. Secondly, my £201 a month is invested and produces a compound annual growth rate of 9%. That could come from growth or income, but in the end I would want to generate 9% a year as income. Those dividends are the source of my passive income, after all.
Choosing shares to buy
Not all companies pay dividends. If I looked at a list of the top dividend payers from 35 years ago, some are probably no longer even around, others have likely cut their payouts, and some may pay more now than they did then.
Companies such as Spirax-Sarco and Diageo have raised their dividends annually for decades.
I would try to reduce the risk to my passive income plan posed by any one share cutting its dividend. I would diversify my investing across a number of shares.
Crucially, I would try to find shares I felt could, on average, help me achieve my 9% compound annual growth target. Compounding my dividends instead of taking them out as cash could help improve my returns while still investing £201 a month.
Quality and value
The sorts of shares I would buy for passive income potential should offer great business prospects and attractive valuations.
An example I would happily purchase now if I had spare cash to invest is Legal & General (LSE: LGEN). The company has a dividend yield of 7.9%. It raised its dividend this year by around 5% and I expect the same next year. If that continued annually, 35 years from now, my purchase today would be yielding 43.6%!
Will that happen? The business cut its dividend after the last financial crisis. But it is highly profitably and operates in a market I expect to see long-term customer demand. Its well-known brand and long history help it attract and retain customers.
If I start putting a couple of hundred pounds each month into a collection of blue-chip shares like that one and compound the dividends, I think I may ultimately be able to hit my passive income target.
