There have been multiple passive income ideas floating around over the past few years. But two of these stand out as the most reliable to me.
Buy-to-let property investing has been around for decades, and for some parts of the UK it can work pretty well. But it’s not exactly the most passive, and it requires a large sum to start.
In contrast, dividend investing can be started with as little as £20 a week (see more below). And once it’s set up, it needs relatively little involvement from me.
Income from dividends
A dividend is essentially a share of a company’s profit. Some companies offer these payments to shareholders in return for investment.
Alternatively, some businesses decide to reinvest their profits to aid growth.
And several will do a mixture of both.
The FTSE 100 has a yield of around 4%. But this large-cap index contains several dividend shares that offer above-average yields.
There are a few considerations to make when looking for reliable passive income, though. A high dividend yield doesn’t necessarily mean it will be consistent.
Factors to consider
Often, double-digit yields are unsustainable or mask a temporarily depressed share price.
Instead, I’d look for companies that have paid a steady stream of dividends over many years. A long payout history can indicate commitment to uphold its dividend policy.
Next, I’d look for shares that have managed to grow their payments over time. This can demonstrate growth in earnings over time.
In addition, the best dividend shares will comfortably be able to afford their desired payout.
Dividend cover is a metric that I look at for this. It shows how many times a company’s payout can be paid from its current earnings.
Reducing risk from shares
To earn consistent passive income from shares, I’d want to own my dividend stocks for many years.
But it’s important to bear in mind that stock prices will move up and down, and if I wanted to sell my shares within several months then I could get back less than I invested.
That’s why this type of investing works best over long periods.
Another way for me to reduce risk is to diversify across several industries. For instance, I wouldn’t put all my money in cyclical mining companies. That would be putting all my eggs in one basket.
In addition to these industrial businesses, I’d also consider shares in pharmaceutical, healthcare and consumer staples companies.
Top picks
So which shares would I buy right now? I already own some dividend shares. But if I was setting up a new passive income plan today, I’d buy Rio Tinto, Taylor Wimpey, Legal & General, British American Tobacco, and GSK.
Each of these shares belong to a different sector group. On average, they currently offer a 7.8% yield, a dividend cover of 1.9 and 22 years of back-to-back payments. That all sounds appealing to me.
If I started with just £20 a week, that equates to £1,040 a year. By owning these five stocks, I’d expect to earn around £81 in passive income.
It might not sound like much right now, but over time I could increase my investment to buy more shares. And more shares would result in more dividends.
