Passive income is money one earns without having to work for it. Do you think that sounds too good to be true? Consider landowners, shareholders and royalty owners. They all get regular payment without having to work for it.
Those people all own something which generates income. But is it possible to earn passive income from a standing start? I think it is. In this article I’ll explain how one can start earning passive income with just 1% of one’s wages.
Action is the key thing
A lot of people dream about passive income. But they don’t do anything to set up such an income stream. For me the critical thing is action.
Even if 1% of my income was just a few pounds a month, I would start saving it immediately to set the foundation for my passive income. Probably I’d set up a standing order to put it into a Stocks and Shares ISA. That way I wouldn’t even notice the money going out each month. At just 1% of my wages I wouldn’t miss it.
Meanwhile, as my regular savings started to accumulate, I would begin to invest it so I could earn passive income. Experts often talk about the difference between “growth” and “income” shares. For example, a share like The Hut Group is primed for growth. A slower moving mature industry throws up shares like BP, where growth prospects look less promising but there is a strong chance of income. Some shares produce both growth and income, which would be a bonus. But I would start finding out more about shares which are known purely as income picks.
Shares I’d pick for passive income
Saving just a small amount each month, my primary focus would be capital preservation. So I’d limit my search to large, well-known companies with long histories of paying out juicy dividends. I’d avoid high yielding shares where I had doubts about the ability of the company to survive and keep paying out dividends.
Then I’d zoom in on industries which tend to produce strong cash flows but don’t have high capital costs. That allows a company to return lots of money to shareholders as dividends. Tobacco is such a choice. That’s why I hold both British American Tobaccco and Imperial Brands. Both provide an excellent source of passive income. Imperial cut its payout this year, but it still has an attractive yield.
Insurance has similar characteristics, and I would look at names like Legal & General and Direct Line. There are lots of other shares I like which currently offer a high yield, such as GSK. But their revenues are more cyclical, which could lead to dividend cuts in a downturn. With a limited amount of savings I’d focus purely on income. That’s why I’d plump for the tobacco and insurance choices at first.
1% of one’s wages isn’t going to make a big difference to lifestyle. But it’s actually enough to set up a foundation for a lifelong passive income. It’s easy to make a start right now – the critical thing is action.
christopherruane owns shares of British American Tobacco, Imperial Brands, and Legal & General Group. The Motley Fool UK has recommended GlaxoSmithKline and Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.