The goal of many investors is to generate streams of passive income. As Warren Buffett once famously said: “If you don’t find a way to make money while you sleep, you will work until you die.”
There are plenty of ways to go about making a second income. I buy dividend shares as I find it the simplest and one of the most effective methods.
I target high-quality businesses with proven business models that have a track record of returning value to shareholders. As such, most of the dividend shares I own are from the FTSE 100.
If I had £12,000 tucked away, here’s how I’d go about creating stable streams of passive income for the years ahead.
Stocks and Shares ISA
If I had a large amount like that saved, I’d want to make it work as hard for me as possible. Over the long run, any small advantages I can get will prove to be extremely beneficial. That’s why I’d invest through a Stocks and Shares ISA.
It’s the perfect investment tool for investors looking to maximise their gains. Every UK investor has a £20,000 limit to use every year. With the profits I’d make through the ISA, I wouldn’t pay a single penny in tax.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Buying the right stocks
Once I’d set that up, I’d start doing my due diligence for which stocks to buy. I mentioned earlier that a lot of those I own are Footsie businesses, so I’d start there.
The firms I buy into need to meet a few criteria. First, they need to operate in a large market. They must have a proven business model. And finally, I want a history of them rewarding shareholders with dividends. Given that dividends are never guaranteed, this is important.
Big yields
One stock I own and would buy more of if I had the cash is British American Tobacco (LSE: BATS). Let me explain why.
One point is that it has a proven business model and operates in a massive market. Over 1.3bn people smoke, last year it sold 555bn cigarettes and £27.3bn in revenue.
Plus it boasts a whopping 9.7% dividend yield, way higher than the Footsie average of 3.9%.
Of course, there are risks with British American Tobacco. One is that governments across the world are clamping down on smoking and introducing new laws that are putting pressure on the company.
But it’s adapting by placing more focus on its New Categories unit, which sells non-combustible goods. The company’s earnings are predicted to grow by nearly 50% every year to the end of 2026.
Taking that 9.7% yield and applying it my to £12,000 ought to earn me £1,164 a year in passive income. That would come in handy. But it’s far off my £23,920 target.
To achieve that, I’d keep reinvesting the dividends. On top of that, I’d add a further £100 monthly contribution. Assuming it kept paying out (which, as mentioned, isn’t guaranteed), compounding at 9.7%, after 25 years my £12,000 would generate £23,920 in passive income a year, or £1,933 a month. That’s more like it.
