Buying into proven blue-chip companies is one way to earn passive income. It has worked for centuries and, while any given company is never guaranteed to pay out passive income in the form of dividends, I feel confident that building a diversified portfolio of high-quality, blue-chip shares ought to help me earn money without working for it, for years or even decades to come.
To illustrate, imagine I had a spare £20,000. Here is how I would use that to target £300 on average in passive income each month.
Doing the maths
How much one might earn from owning certain shares is fairly simple to work out, with the caveat that what happened in the past might not be a guide to what to expect in future.
We use something called dividend yield. Yield is basically how much I ought to earn per year in dividends as a percentage of what I invest.
So, if I invest £20,000 at a 7% yield (well above the FTSE 100 average but I think an achievable number in today’s market while sticking to blue-chip shares), I ought to earn £1,400 per year in dividends.
A watchout – and a game changer
As I said above, whether that happens depends on what companies choose to do with their dividends.
Not all companies pay dividends. Among those that do, some keep them level for many years in a row, some suddenly cut them, and others raise them regularly. So buying into the right companies will be critical to success in my passive income plan.
Still, £1,400 annually equates to dividend income of roughly £116 per month – welcome unearned cash, but little more than a third of my target.
So I would use a game-changing simple investment technique known as compounding. That means reinvesting my dividends so I can buy more shares and in turn hopefully earn more passive income. Doing that, after 14 years I ought to hit my monthly £300 target.
It’s important to find the right shares to buy, at the right price
What sort of shares would I be looking for to build that diversified portfolio with its average 7% yield?
An example of the sort of share I would consider is one I already own in my portfolio: Legal & General (LSE: LGEN).
The FTSE 100 financial services company operates in a market I expect to benefit over the long term from high customer demand. It can tap into that thanks to a number of competitive advantages. Those include an iconic brand, large customer base, and deep expertise in financial markets. It has also made moves in recent years to capture new, younger parts of the market, for example, by emphasising the social credentials of some of its investing.
There are risks. Legal & General cut its dividend during the 2008 financial crisis. A weak economy could again hurt markets, potentially hurting profits.
Making the first move
Still, with its 9% dividend yield, I think the share price reflects the risk. I see the current price as good value and continue to hold the shares.
How would I start with my passive income plan? My first move would be to put the £20,000 into a share-dealing account or Stocks and Shares ISA.
