Passive income can come from lots of different sources. One approach I like is to invest in proven blue-chip companies I hope will pay sizeable dividends in future, without me needing to do any work for them.
At this time of year, with the annual deadline for contributing to an ISA falling in the week ahead, a lot of attention is paid to trying to put as much as one can into an ISA in time.
But not everyone has a spare £20,000 lying around right now – or even a spare £20.
Thankfully, even a few pounds a day can help build long-term passive income streams.
I already have a Stocks and Shares ISA. But if I did not, I would open today. Then, drip feeding in three pounds a day, here is what I would do.
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Dividend quality, not just dividend yield
A daily £3 would add up to almost £1,100 in a year. That is not an insubstantial sum to invest.
Still, how much passive income might I earn?
With a 10% dividend yield, around £110 per year. But the average FTSE 100 yield is closer to 4%, meaning one year’s investing would earn me less than a pound a week in dividends.
One possible response to that is to buy high-yield shares. But dividends are never guaranteed. A high yield can end up going to zero overnight.
So when choosing shares for my passive income plan, I would focus on finding shares in great businesses that are selling at attractive prices. Only then do I pay attention to yield.
After all, I like the passive income prospects of high-yield shares as much as the next investor – but not only because of the yield.
Finding shares to buy
Let me illustrate what I mean by looking for a great business with an attractive share price.
M&G (LSE : MNG) is a well-known asset manager. The fact that its name has widespread recognition among target consumers helps to give it a competitive edge. It can attract new customers. Already, the firm has millions of clients.
Demand for asset management could move around. For example, with a weakening economy, customers may need their money more, so pull out funds. That may hurt earnings at M&G.
Over the long run, though, I expect high demand for asset management. That could help offer up an ongoing pool of potential customers for M&G.
The business looks cheap to me – it has generated sizeable cash surpluses in recent years, but has a market capitalisation of under £6bn.
The dividend has grown annually in recent years. M&G has a yield of 8.4%. So if I invested £100 today, I would hopefully earn £8.40 per year in passive income.
Aiming for the target
I would buy a range of shares, as not all may do as well as I hope.
But even if I managed an average yield close to M&G’s – say 8% — that would still earn me under £90 annually on my year’s savings of £3 daily.
Imagine, though, if I kept putting £3 in per day, while reinvesting the dividends.
Doing that, after 16 years I ought to be earning over £200 per month on average in passive income.
