The idea of passive income is simple and attractive – money comes in without having to work for it. But how can one turn this idea into a reality? I use shares as passive income investments.
With just £200 a month, here’s how I’d use passive income investments to boost my income.
There’s a reason I like UK shares as passive income ideas. It’s because they really are passive. I can buy shares in a company and sit back to wait for any dividends. I do some research before investing and may choose to spend some time monitoring my investments. But I can earn dividend income without using a lot of time.
Not all shares pay dividends, so I look for companies that are likely to pay them. There is never any guarantee – even a company which regularly pays dividends can decide not to do so in future, for example. So I try to choose firms with strong cash flows and whose business prospects are attractive to me. By investing in a number of different companies, I can reduce my risk if any one company underperforms.
£200 might not sound like much to start making passive income investments. But putting that amount aside each month soon adds up. In a year it would add up to £2,400. So I would try to focus on the discipline of saving a set amount regularly. I’d put it into a Stocks and Shares ISA and then start buying shares.
As dividends hopefully start to pile up, I would have a choice. I could take them as cash. Alternatively, I could reinvest some or all of them into more shares. That would result in less passive income in the short term. But it would help me boost my capital which I could use to invest in more shares.
Shares as passive income investments
Before investing, I would learn more about the companies from which I was hoping to earn passive income.
From an income perspective, it can be attractive to invest in “high-yield” shares – ones which pay out a large dividend relative to their share price. But sometimes, a share offering a high yield can be a warning sign that investors lack confidence in its ability to keep doing so. So I look at a company’s recent annual accounts to understand some important information. For example, how much free cash flow is it typically able to generate? How much debt is it carrying? What does the company see as its business outlook? These help me assess how likely it seems that a company will be able to pay out at a certain level in future.
I also want to make sure I am diversified across different passive income ideas. For example, tobacco shares like British American Tobacco and Imperial Brands have attractive yields compared to most FTSE 100 shares. But declining cigarette consumption in many markets is a big risk in my view. So I only keep a small part of my portfolio in tobacco companies. Tempting though high yields can be, I think an important part of choosing passive income investments is getting the right mix of risk and reward for me.
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Christopher Ruane owns shares in British American Tobacco and Imperial Brands. The Motley Fool UK has recommended British American Tobacco 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.