There are many different ways people try to (and sometimes do) earn passive income.
An approach that works for me is to invest in blue-chip shares. If they pay out excess cash to shareholders in the form of dividends while I own the shares, I will be line for my part of it.
That can turn out to be a lucrative passive income stream. If I had a spare £8,900 in savings, here is how I would aim to generate monthly passive income streams of £256 with it.
Should you invest £1,000 in Diageo right now?
When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Diageo made the list?
Setting up an income-generating portfolio
My first move would be to put my money into an account I could use to buy income shares.
That could be a share-dealing account or a Stocks and Shares ISA. There are lots of options so I would do some research to choose the one that suited me best.
By the way, even with less than £8,900 (perhaps much less) I could take the same approach – though it would take me longer to hit my goal.
Earning dividends can be simple
Not all shares pay dividends, even if they have done so in the past. So I would diversify my portfolio across five to 10 different companies and choose each one carefully.
A dividend is basically paid from the excess cash a company has on hand. I would therefore look for businesses that could consistently generate more money than they need for reinvesting in growth – and are happy to pay it out to shareholders (as some firms make lots of money but do not use it for dividends).
Finding shares to buy
When hunting for such potential investments, I would limit my search to areas I felt I understood. I would look for proven business models and manage my risks carefully.
As an example, consider my investment in ITV (LSE: ITV). The company has two businesses. It broadcasts programmes, but it also has production facilities for making them that can be hired out to other content producers.
So while the decline of traditional broadcasting is a risk for both revenues and profits, the proliferation of new media companies could help production demand stay high. On top of that, ITV has been working hard to expand its digital footprint.
The company has been consistently profitable in recent years. It aims to pay at least 5p a year in dividends and managed to do so last year. That equates to a dividend yield of 6%.
An income target
A dividend yield is basically how much I will hopefully earn in dividends annually from a share expressed as a percentage of what I pay for it.
At 6%, £8,900 ought to earn me £534 in dividends annually – welcome, but far below my target.
Reinvesting along the way
All is not lost however. I can ‘compound‘ by reinvesting my dividends as I go instead of taking them as cash.
Doing that, after 30 years, my portfolio ought to be generating £256 a month on average of passive income. That is all from investing £8,900 today and reinvesting the dividends.
