Thinking of investing money in dividend shares over time, with the aim of building a long-term passive income stream?
Lots of people do that. With the right approach, it can be lucrative.
So how much does it take and how much passive income might it earn? The first question is easy to answer – such a passive income plan can be adapted to an individual investor’s funds, little or large.
Calculating possible income from dividend shares
The second question, what it might earn, is a bit more complicated. There are three factors that determine how much passive income someone is likely to earn from dividend shares.
One is how much they invest. A second is how long they hold the shares for. The third is what is known as dividend yield: the annual dividends earned expressed as a percentage of what the shares cost.
As dividends are never guaranteed to last, yield can be estimated in advance but the reality may turn out to be different, for better or worse.
Targeting income at a certain age
As an example, let’s work backwards. Imagine someone wants to start earning £30k a year of passive income at age 55.
We will presume that they achieve a compound annual growth rate of 7% for a period and then a dividend yield of 7% at 55. That is slightly over double the current FTSE 100 yield but in today’s market I think it is achievable, sticking to blue-chip shares.
If the investor only has 10 years (because they start at 45), hitting that target will require a monthly investment of almost £2,500.
Starting at 35, they can hit the same target by age 55, by putting in around £830 a month. In other words, doubling the timeline does not mean the monthly contribution is halved. It is more than halved, thanks to the power of compounding.
It is never too late to start investing. But taking a long-term approach can mean time is something that works in your favour, not something you need to race against.
Finding shares to buy
One share I think investors should consider for its passive income potential is FTSE 100 asset manager M&G (LSE: MNG). The company has what is known as a progressive dividend policy. So it aims to grow its dividend per share annually. In the past few years it has done so and currently the yield stands at 7.8%.
Can that last? On the positive side, the market for asset management is huge and likely to stay that way. M&G has a large customer base in multiple countries, its brand is powerful and it has demonstrated that is able to generate substantial spare cash. That can be used to pay dividends.
What might go wrong? One concern is whether weak performance or rocky markets could lead investors to pull out more funds than they put in, hurting profits. The first half was reassuring this way, but M&G has battled this problem in the past and it remains a risk.
Getting started
Of course, all the above sums may sound fine in theory – but unless someone takes some action, knowing how to earn passive income will not be enough!
A good first step is selecting a share-dealing account, Stocks and Shares ISA, or share-dealing app.
