A little more income would often come in handy. I think that is a sentiment many people feel at some point – but a lot of them do nothing about it. My own approach is to try to increase my passive income streams. Those are sources of earnings that do not require work from me.
One such stream is investing in dividend shares. Unlike buying a rental property or some other passive income ideas, it is possible to do that even when starting with little money. Here is how I would use £10 a week to try and earn such income for the rest of my life.
Small threads for giant tapestries
The Bayeux Tapestry is an impressive feat. Well over 70 yards in length, it is thought to be over 900 years old. This massive, durable tapestry is composed of lots of small bits of wool.
I think of investing in similar terms. A few pounds might not go far at the pub or paying bills. But when lots of small sums are added together, they can start to form the basis of something much bigger.
Putting £10 a week aside, I would accumulate £520 in a year. I could use that money to invest in dividend shares. Over time, hopefully the dividends paid on those shares would start to add up.
The average yield of FTSE 100 shares at the moment is around 3.5%. If I invested £520 at that yield, I would expect annual passive income of around £18. But remember that each week’s saving is only one small part of a much bigger picture. In the second year, I would hopefully still receive dividends from shares I bought the year before as well as new ones I added. So even though I would be putting in a constant £10 a week, hopefully over time my passive income streams would grow.
The practicalities of investing
Starting to save £10 a week sounds fairly straightforward on paper. But in practice, a lot of people find it hard to save consistently. Other spending priorities pop up or sometimes they simply forget their positive intentions. So I would consider setting up some sort of automated payment to help me stay disciplined in this regard.
To buy shares once my cash pile has grown big enough, I will need some sort of share-dealing account, or Stocks and Shares ISA.
I would set that up in advance of when I expect to start buying shares. That way, it should be ready to use when I identify the first share I think could be a promising fit for my investment objectives.
Dividend shares as passive income streams
While the money starts to add up, I would use the time to learn about the stock market and decide what sort of shares would be right for me.
Not all shares pay dividends, even if the companies are successful. As I am targeting income, I would stick to shares that do. But another question is what will happen next. After all, a company can cancel its dividend at any time. So how do I know whether a company will pay dividends in the future?
The short answer is that I can never be completely sure. But I can focus my search on companies that have the right sort of business economics for them to pay a dividend. For example, ITM Power is consistently lossmaking. As it remains in a development phase, I expect it may remain lossmaking for years to come. So there seems little chance to me that it will pay any dividends. It is not making a profit that could fund a dividend. Even if it did make a profit, it would likely want to use the money to help grow the business faster.
Contrast that to Legal & General. It has been consistently profitable in recent years. Its business of insurance and financial services is fairly mature, meaning the company can do well even without investing in new areas of business. It generates substantial free cash flow and has set out its dividend strategy, including raising the payout over the next couple of years.
Finding dividend shares to buy
Even that does not guarantee that Legal & General will pay a dividend. After all, an unexpected event like severe storm damage could hurt profits. That could lead the company to suspend its dividend. But between these two companies, I would say Legal & General looks far more likely than ITM Power to pay a dividend next year. Currently its dividend yield is 6.6%.
What is important here is that I did not reach this conclusion by looking at the firms’ dividend history. Instead, I tried to understand whether it would be likely to have the means and motivation to pay dividends in future. Businesses can change and markets shift. So as an investor, it is important for me to keep forward-looking when assessing a company’s potential.
When doing this, one of the things I look for is whether a company has an enduring competitive advantage that could help it stay profitable. That could be a unique brand like Reckitt’s Dettol line of products, a patented formula like some of the drugs sold by AstraZeneca, or a distribution system that cannot easily be replicated, as seen at National Grid. Whatever it is, such an advantage could help attract and retain customers, which is necessary to keep dividends flowing.
Passive income for life
I would make sure to invest in a range of shares. That way, even if one of them slashed its dividend in future, my overall passive income prospects may not be too affected.
With just £10 a week and the discipline of regular saving, over time my investments and the passive income I received from them would hopefully start to add up. If I keep going, adding more money each week and not cashing in my portfolio, I could reasonably hope to earn at least some passive income for the rest of my life.
