One of my favourite passive income ideas I like to use (and do already) is buying dividend shares.
Not all shares pay dividends and those that do can stop at any time. But by building a diversified portfolio of carefully-selected blue-chip companies with proven business models, I would hope to earn substantial and indeed growing passive income streams over the course of time.
One share I already own for income
Let me illustrate by discussing some pros and cons of me owning three specific shares – two of which I already own and one I would be happy to buy if I had spare cash.
The first example’s British American Tobacco. The company makes and sells tobacco products globally under a range of brands such as Lucky Strike.
Such premium branding, combined with the addictiveness of tobacco, mean that the company generates a lot of free cash flow. It has a sizeable amount of debt, but still the dividends are big.
The payout per share has grown annually for decades. At the moment, the share has a dividend yield of 8.3%, meaning that I ought to earn £83 in passive income annually for every £1,000 I invest today.
Always consider the risks
Still, whether that happens depends partly on how well British American navigates a landscape of changing habits, as global cigarette sales look set to shrink over time.
All businesses face risks – and successful investors take them seriously. M&G (LSE: MNG), for example, could see rocky economic markets reduce demand for its asset management services. Even in a strong market, if its managers don’t perform well, clients may take their money elsewhere.
Still, the long-term demand picture for asset management seems better to me than that for cigarettes. M&G has a well-known brand and large customer base. It operates in a couple of dozen markets and has both retail and institutional clients.
The business has a proven capability to generate cash that has let it pay sizeable dividends.
The current yield of 9.4% is among the highest of any FTSE 100 company. M&G aims to maintain or increase its dividend per share each year. If it delivers on that (and remember no dividend’s ever guaranteed),my stake could see me earn growing passive income streams in years to come.
Doing the maths
I would also be happy to buy into insurer Aviva, which announced a dividend increase this week. It benefits from a large customer base and well-known brands. I think its strategy of trying to cross-sell more products to existing clients seems to be working.
The firm cut its dividend in 2020 and one risk I see is rising claim settlement costs eating into long-term profitability. But I like its prospects – and the 6.7% yield.
Investing equally in those three income shares, my average yield would be 8.3%. So if I invested a little under £55,000 today, I’d be on track for average passive income of £380 a month. With less money, I could follow exactly the same approach on a smaller scale.
