I think sometimes people can get a little confused about the effort needed regarding passive income investments. Although the money made from it should be easier to come by than active investments, I still need to put in effort. Most of this effort comes at the initial stage, when I research what my strategy is and what money I can afford to invest. As this is the key part of the process, it’s worth discussing it in more detail.
Using dividend shares for passive income
Clearly, there are many different investments that can be classified as generating passive income. As a stock investor, the main one I’m focused on is dividend shares.
Dividend shares offer me passive income via the quarterly, semi-annual, or annual payments to shareholders. By investing in the stock, I become a shareholder of the company. In this way I have a right to receive a part of the distribution of the profits. This is known as a dividend.
It’s passive simply because the directors of the business are the ones that put in the effort to try and make a profit. I don’t have to get involved in the day-t0-day running of operations. Yet by stumping up my cash and investing, I am entitled to whatever dividend is paid out.
Naturally, like any passive income investment, dividend shares do have risks. The income payout is not guaranteed, and depends on how the company has performed in the past year. Dividends also vary from year to year. This can make it hard to accurately forecast how much income I could receive in the future.
Putting my £500 a month to work
The thing I like about dividend stocks is that there is no minimum investment size to get the ball rolling. This allows me to start generating passive income this year, even if I don’t have a large lump sum available right now.
For example, the FTSE 100 average dividend yield is just under 3%. By putting in the research I mentioned at the beginning, I’ll aim to target sustainable dividend paying firms with above average yields. I think I can target 5% yields at present.
So with my £500 a month, at the end of the first year I’d have an investment pot of £6,000 generating passive income of £300 into year two. Over time, the dividends really start to add up. After 10 years, I could have a pot of £60,000 and accrued dividends worth about £17,500!
Logically, the amount of passive income I’ll have earned in year 10 is much higher than year one. This shows to me the value in being patient and not trying to chase things. £500 a month is plenty to get me started on my passive income investments, as it’ll really add up (as shown above).
jonathansmith1 has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.