One way to earn passive income is to invest in proven blue-chip companies that pay dividends to shareholders.
Not all companies do that. But many do. In fact, FTSE 100 companies currently pay tens of billions of pounds each year to shareholders. So buying carefully chosen shares can be a way of earning income thanks to the success of such businesses, without having to work for it oneself.
If I had a spare £8,000 and wanted to put this passive income idea into practice, here is how I would go about it.
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Getting ready to buy shares
My first move would be to put the £8,000 into an account I could use to buy shares.
So, if I did not already have one, I would set up a share-dealing account or Stocks and Shares ISA.
How to go about finding dividend shares to buy
My next move would be to learn about how the stock market works.
Being able to read a company’s balance sheet and accounts can help me see how the business is doing financially. I can then use my judgment as to what might happen in future when it comes to the dividend. For example, I consider how large a firm’s potential market is and what sets it apart from rivals in that market.
In other words, I first look for what I see as great businesses with strong future potential and consider their valuation. Only then do I start to weigh the attractiveness of the prospective dividend compared to other options.
Rather than putting all my eggs in one basket, I try to reduce the risk of a disappointing investment by spreading my money across different shares. £8K would comfortably be enough for me to do that.
An example in practice
To illustrate this approach, I can point to one of the shares in my passive income portfolio: M&G (LSE: MNG).
From a price perspective, the asset manager has not been an impressive performer. Since listing on the London market in 2019, its shares have fallen 9%.
But the dividend yield is 9.6%, meaning that if I invested £100 today I would hopefully earn £9.60 in passive income each year.
M&G aims to maintain or increase its per share dividend annually, although as with any share that is not guaranteed. I expect the asset management industry to benefit from resilient long-term demand.
With a strong brand, large customer base, and deep expertise in asset management, I think M&G could continue to generate the levels of excess cash it needs to sustain its generous dividend.
It is a competitive industry, though, and if management results are weak, there is a risk that customers could pull out funds, hurting M&G’s profits.
Aiming for a target
In practice, M&G’s yield is well above its FTSE 100 peers’ average. But in the current market, I think I could realistically target a 7% average yield while sticking to proven blue-chip companies.
A 7% yield on £8K is £560 a year. To boost my passive income, though, I could initially reinvest the dividends.
Doing that for a decade ought to mean that I would be earning around £1,100 annually in passive income 10 years from today.
