I’d build an extra income with a spare £3 a day like this

Christopher Ruane explains how putting just a few pounds a day into the right dividend shares could hopefully help him build extra income streams.

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Some extra income could always come in handy! But earning more does not always have to involve working harder. Millions of people top up their income by investing in shares, then letting the dividends roll in.

One benefit of that approach, in my view, is that it does not need to be expensive. With even a few spare pounds a day, I could start buying income shares I hoped would pay me dividends for years, or perhaps decades, to come.

Here is how I would aim to do that for just £3 a day.

Small, consistent saving

I would try to get into the habit of regular saving, giving me the funds to start building a portfolio of dividend shares. £3 a day might not sound like much. But it adds up to almost £1,100 a year.

To get going, I would set up a share-dealing account, or Stocks and Shares ISA and make regular contributions to it.

All dividends aren’t equal

My plan to earn extra income is based on receiving dividends from shares. But while some shares pay large dividends, others pay none at all. But remember, no dividend is guaranteed from any share.

So rather than focusing too much on the current dividend yield (a share’s annual dividend expressed as a percentage of my purchase price), I would focus my attention on what I think its long-term dividend prospects look like.

Specifically, I would be on the hunt for businesses I felt could generate sizeable free cash flows. I would look for firms that seem likely to return those to shareholders as dividends, rather than use them for something else like investing in expansion.

Finding shares to buy

What might be an example? Consider one share from my portfolio: British American Tobacco (LSE: BATS).

Cigarette usage in many markets is declining, so that poses a risk to revenues and profits. But demand for tobacco in various formats remains substantial.

With its portfolio of premium brands like Lucky Strike, the business can charge a premium price. But cigarettes are cheap to make, meaning British American’s profits are substantial.

Even with declining cigarette sales in many markets, I expect the FTSE 100 manufacturer to continue generating large free cash flows. It has raised its dividend every year this century and currently yields 10.1%.

Weighing risks and rewards

The falling British American Tobacco share price (it is down 25% over the past five years) may suggest that many investors are nervous about the risks to its business posed by declining cigarette sales. I think that is reflected in the price and high yield.

I also expect the company to use its assets, including well-known brands and a large sales network, to increase sales of non-cigarette products fast.

By owning British American alongside other shares in my portfolio, I am generating extra income. That income has been growing, thanks to the annual dividend increases.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has positions in British American Tobacco P.l.c. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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