Passive income is defined as income that’s not earned from working. There are many different types of passive income. For example, buy-to-let property income, book royalties, dividend income, and music royalties are all different passive income streams. They all have various benefits and drawbacks, and some may be more suitable for some investors than others.
I believe investing in dividend shares is one of the easiest ways to generate a passive income. Unlike other strategies, such as buy-to-let, investors do not have to have a substantial lump sum to get started. Anyone can buy stocks and shares. Most online stockbrokers allow investors to get started with investment funds from as little as £50 a month.
Of course, the strategy does have its drawbacks. Equity markets can be incredibly volatile, and there’s no guarantee an investor will receive any income at all. For example, in the first half of last year, many former dividend champions decided to eliminate their dividends to try and preserve cash in the pandemic. Investors who had been relying on these companies to provide a steady passive income received no compensation.
However, while some companies eliminated their dividends, others didn’t. Some businesses have increased their distributions to investors over the past 12 months.
I would focus on these companies to build a passive income portfolio with just £100 a month. These businesses might offer a lower dividend yield to investors at first, but I’m happy with this trade-off. I would rather accept a lower rate of return for the chance of more security than a higher rate of return and risk my money.
Another way to reduce risk is to invest in equity funds. I think this would be the best strategy for me to invest £100 a month. While it’s possible to build a portfolio of single stocks with this level of funding, it would be difficult to build enough diversification, to begin with. Investing in a fund may allow me to invest in a basket of securities at the click of a button without having to worry about diversification.
Passive income strategy
One of my favourite income funds on the market at the moment is TB Evenlode Income. This fund owns a portfolio of blue-chip stocks such as Relx and GlaxoSmithKline. It supports a dividend yield of 3% at the time of writing. The minimum investment is £100 a month, making it the perfect fit for my monthly investment criteria. My figures suggest that after a year of investing £100 a month, this fund could be throwing off £36 worth of passive income per annum.
After 10 years of this, assuming no income growth or capital growth, the annual passive income would be £400. That’s assuming all income is reinvested. By increasing deposits, it would be possible to increase this amount.
This is not a one-size-fits-all solution, and there are plenty of risks associated with fund investing. The Neil Woodford debacle showed just how damaging fund investing could be to investors if the manager is not properly vetted. Investors also need to be aware of high fees and underperformance. It can be a mistake to concentrate purely on income and ignore these factors.
But as a way to generate a passive income with minimal effort, I would still buy TB Evenlode Income.
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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended GlaxoSmithKline and RELX. 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.