Passive income ideas come in many shapes and sizes.
Some are new, but one that is old – very old – is buying shares in businesses in the hope of earning dividends.
That can be a way of turning even just a fiver a day into a monthly passive income in the hundreds of pounds.
Here’s how.
Start putting aside money regularly
The same approach could work with more, or even less money. The income earned would be correspondingly different.
But a key element, whatever the amount, is consistency.
Forming a habit of making regular contributions can help set the stage for growing passive income streams.
Choose a suitable investing platform
In the very beginning, that £5 a day could simply be put in a jam jar on the windowsill.
The cash cannot sit there forever, though, if it is supposed to generate dividends. That will take dividend shares – and a way to buy them.
So an early step in this passive income process would be to choose a share-dealing account, Stocks and Shares iSA, or trading app.
Learn what you need to know
Dividends are never guaranteed, even if a company has paid them in the past. Not only that, but buying dividend shares that then fall in value could lead to a capital loss.
So, it is helpful to get to grips with important concepts like the relationship between free cash flow and dividends and share valuation before starting to build a portfolio of dividend shares.
Compound now for future income
It can feel good when the dividends start coming in. But rather than spend them, a smart move initially can actually be to reinvest them.
Doing that allows the portfolio to grow in size faster than it could do with just the £5 a day ongoing contribution.
Compounding that £5 a day at 6% annually for 25 years, the portfolio should be worth over £100k.
At that size, a 6% dividend yield would mean £500 of passive income per month.
Building the portfolio
A key step is choosing the shares to buy.
6% is around double the current FTSE 100 yield. I see it as achievable, but it is important not to chase yield while ignoring risks. A high yield can be a sign that the City sees potential for a dividend cut.
One share I think investors should consider already yields close to 6%, at 5.7%. It also has an enviable track record of annual dividend increases stretching back decades.
That share is FTSE 100 cigarette manufacturer British American Tobacco (LSE: BATS).
Past performance is not necessarily a guide to what to expect, even though the firm aims to keep growing its dividend annually. Falling cigarette sales volumes already mean the company’s revenues are in decline – and that could get worse.
Others may not want to invest in tobacco companies on ethical grounds.
Still, there are a lot of strengths to the company too. It has strong brands, an efficient manufacturing operation, excellent distribution in much of the world, and a proven business model.
It remains a cash flow machine, helping fund billions of pounds of passive income each year, in the form of dividends.
