With the cost of living rising, earning passive income has never been more important. And investors can do this by just following three simple steps.
The first is figuring out where to get the cash to invest, the second involves identifying stocks to buy. And the third is just repeating the first two.
Cash
There’s no way around the fact that buying dividend stocks takes cash. But that doesn’t mean investors need to have thousands in the bank before building a portfolio.
One way of making a start involves using part of a monthly salary. Putting aside part of a regular income from work to buy shares can be a great way of getting started.
Over time, this can be a powerful force. Investing £200 each month at 5% for 10 years can generate £1,424 per year – or £118 per month – in passive income.
The question is where to find stocks with a 5% yield. And I think the UK markets are a great place to look.
Dividend shares
Right now, UK shares trade at a significant discount to their US counterparts. That’s why there have been so many attempts to acquire FTSE 100 and FTSE 250 companies lately.
One good example is British American Tobacco (LSE:BATS). Shares in the tobacco business currently come with a dividend yield in excess of 9%.
A high yield can often be a sign of high risk and there’s clear danger with British Tobacco. The company’s largest division – combustibles – is probably in structural decline.
Pessimism can often be a source of opportunity, though. And British Tobacco has some interesting growth prospects with its Velo nicotine pouches.
Investing and reinvesting
I think British American Tobacco has some way to go before it stops being able to pay its dividend. It’s unlikely to grow, but I don’t expect it to be cut any time soon.
In the meantime, the company is going to distribute a lot of cash to its shareholders. And investors can reinvest that in other companies to generate even more income in future.
Unilever, for example, is a stock with a positive long-term outlook as demand for household cleaning products doesn’t appear to be in structural decline. It also pays a regular dividend.
Reinvesting dividends from British Tobacco into other stocks could be a good way of adding some diversification to a passive income stream. And this could also reduce the risk.
Simple… but not easy
There’s nothing intrinsically complicated about earning passive income. But identifying stocks to buy isn’t easy.
Companies need to be able to earn enough cash to pay shareholders for a long period of time. And they need to be trading at a low enough valuation to provide a decent yield.
Right now, though, UK shares look like a good place to be searching for stocks to buy. The discount to their US counterparts could be a great opportunity for investors.
