While people talk about buying dividend shares as a way to earn passive income, how does such an approach actually work in practice?
The answer is that it depends on the approach somebody takes.
Indeed, that is part of what I see as the appeal of a passive income plan based on buying dividend shares. It is flexible and can be matched to an individual’s own financial goals and circumstances.
Setting a target, then creating a plan
For example, imagine that someone wants to earn an average of £1,000 per month in passive income. That adds up to £12,000 per year.
Currently, the FTSE 100 index of leading British shares yields 3.1%. But I think an investor could realistically target a higher yield in today’s market, while keeping a close eye on business quality and likely dividend sustainability.
Say they target a 5% yield. That would require a £240,000 investment to hit the passive income goal.
If the investor put that money in over the next year, they could possibly be earning what they want in dividends a year from now.
But a slower, gradual approach could also work – again, this sort of flexibility is one reason I like owning dividend shares as a passive income generator.
If the person has an empty ISA today and starts putting in £1,000 each month, then reinvesting dividends along the way, after 14 years it ought to be large enough to generate £1,000 in monthly passive income at a 5% yield.
Taking a disciplined approach
That may sound fine in theory, but how might it work in practice?
I do not think it need be complicated. But it does help a lot if someone has the discipline to form a plan of action and stick to their goal of making regular contributions.
Before doing that, they need to have an investment platform they can put their money into and use to buy shares. That might be a SIPP or a Stocks and Shares ISA. Or it could be a share-dealing account or trading app.
Each has its own pros and cons so it makes sense for an investor to take some time to find one that suits their own needs well.
Finding income shares to buy
My example above presumed a 5% average yield from a diversified portfolio. That is well above the average FTSE 100 yield right now, but I think it is a realistic target while sticking to proven blue-chip companies.
One share I think passive income hunters should consider is M&G (LSE: MNG).
The FTSE 100 asset manager aims to grow its dividend per share annually, as it has done over the past few years. That already sounds appealing to me but especially given that M&G’s current yield stands at a juicy 7.4%.
With its strong brand name, multinational presence, and customer base in the millions, I think M&G has what it takes to keep on generating sizeable amounts of excess cash over time, helping it to fund the dividend.
Will that last? Any share has risks and M&G is no exception. One risk I see is market turbulence leading investors to pull more money out of M&G’s funds than they put in. That could hurt its earnings.
Still, I like the company’s long-term cash generation prospects.
