If your goal is to earn money without working for it, why would you instead spend money before earning a penny? What sort of passive income plan is that?
It can actually be a very lucrative one – and one that is widely used. Buying blue-chip shares that pay dividends costs money. But it ticks the key passive income boxes: it is effortless and can generate income.
Here is how that might work for someone targeting £1,000 each month on average in income (I ought to add that it could also work for a higher or lower target, but the sums invested will need to be adjusted accordingly).
Have BP, Tesco, Vodafone and more working for you!
I mentioned blue-chip shares above. Those are large, well-established companies like Tesco, BP and Vodafone. Being big and having a successful past is not necessarily an indicator of how a firm may perform in future. It is still important to look into each individual share being considered, and to diversify the portfolio across a range of companies.
But my point is that this passive income plan is not based on tiny companies few people have heard of. My preference is to stick to proven, blue-chip businesses and let their hard work provide income in the form of dividends.
A four figure monthly income
A target of £1,000 a month in passive income adds up to £12k a year. Currently, the FTSE 100 yields 3.1%. That means it pays roughly £3.10 in dividends annually for each £100 invested.
I think a higher yield is achievable, while sticking to blue-chip shares. Let’s say 6%. At that rate, the ISA would need to be worth £200k to earn the target income of £1k a month.
It’s possible to start with nothing
So someone with a spare £200k in their ISA could get going immediately.
What about someone with an empty ISA or none at all? They could start by choosing the right Stocks and Shares ISA for them, then putting in £20k a year for a decade, drawing dividends along the way.
Or they might try to speed things up, by reinvesting (compounding) the dividends at first. After nine years compounding at 6% annually, the ISA should be worth over £200k, at which point the dividends could be used as passive income.
Here’s a blue-chip share to consider
I mentioned a few blue-chip shares above, but the highest yield in that trio is the 4.2% offered by BP. A higher yield — 5.8% — is offered by British American Tobacco (LSE: BATS). That is still not 6%, but could form part of a portfolio that hits that target.
Not everyone feels ethically comfortably investing in tobacco companies. For those that do, I see British American Tobacco as a share to consider.
It is one of only a few FTSE 100 shares that have grown their dividend per share annually for decades. It plans to keep doing so, but declining cigarette usage is a risk both to revenues and profits. Despite its premium brands pricing power and a non-cigarette business, revenues have fallen for three years on the trot.
But the company still sells large volumes of cigarettes and is massively cash generative. It has long experience of navigating difficult markets — and I believe it can keep doing well.
