These days, passive income ideas are a dime a dozen, but many require an excessive amount of time or money to get started. Full-time workers seldom have the time, and part-time workers seldom have the cash.
So how can the average person bring in extra income with just a few quid a day and minimal time?
There are a few options, but my favourite is investing in reliable companies with a proven track record of paying dividends. Such companies regularly reward shareholders by paying out a percentage of their holdings in cash or shares.
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The beauty of this method is that it requires minimal cash and time to get started. All it takes is an investment account and a few quid a day.
For UK residents, investing via a Stocks and Shares ISA is the most tax-efficient option, with a £20,000 a year tax-free allowance.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The benefits and risks
The key benefit of investing in dividends is the simplicity. A bit of research reveals top dividend-paying companies and from there, it’s a simple matter of choosing how much.
There’s no need to go all in on day one. Even as little as £5 is a good start. This way, first-time investors can get a feel for what works without staking too much.
Then there are the risks.
Stock prices go up and down, so even if a company pays decent dividends, there’s a chance of losing money. There are ways to gauge which companies are likely to perform better but there’s no guarantee.
To mitigate these risks, it’s best to pick several stocks from a variety of sectors to avoid a single point of failure.
What to look for in a dividend stock
Many companies pay a dividend but not all are considered dividend stocks. True ‘dividend stocks’ are those that pay consistently and have a high yield.
The yield is the percentage returned per year. For example, a 5% yield on a £1,000 investment would return £50 a year.
But dividends alone don’t mean the company is reliable. It’s also important to assess the business by gauging the viability of its products, its position in the industry, and its accounts.
Applying the above concepts
A passive income portfolio may consist of popular FTSE 100 stocks like HSBC, Legal & General, Tesco and BT Group. These are all well-established companies with a track record of paying higher-than-average dividends.
But one stock I like at the moment is Aviva (LSE: AV.). The massive insurance firm recently secured a deal to acquire struggling motor insurer Direct Line for a 22% discount. If it can revive the firm, the purchase could pay off in spades.
Lately, the shares have been on a bit of a downer but they’re still up 6.5% this year. That means it’s outperformed major competitor Prudential, down 25%.
Dividend-wise, it’s impressive, with a 7.4% yield and a 73% payout ratio.
Unfortunately, it’s made several cuts over the past 20 years during weak economic periods. That adds a risk that more cuts could happen if things go south.
But with the new acquisition, analysts forecast growth in the coming year. I believe the combination of growth and dividends could make it an excellent addition to a dividend portfolio.
That’s why I recently bought the shares and plan to buy more next year.
