The prospect of earning money with no extra work has appeal year after year. But not every passive income plan works well every year.
My own approach to generating passive income includes investing money in shares that can pay me dividends. I am hoping that could work really well for me in 2023.
Dividend yield and income streams
An important concept to understand when it comes to shares is dividend yield. Basically, that helps me know how much money I ought to earn in dividends each year from holding a particular share (if the company keeps its payout steady, which is never guaranteed).
As an example, Tesla does not pay a dividend, so has a yield of 0%. Tesco has a yield of around 4.8%, meaning I should earn roughly £4.80 in annual dividends for every £100 I invest in its shares today. Gas company Diversified Energy yields around 13%. So if I put £100 into its shares today, hopefully I would generate around £13 of passive income each year.
So ought I just to try and maximise my earnings by buying the highest yielding shares? Definitely not! Remember, I said above that dividends are never guaranteed.
As an example, Diversified was lossmaking last year and the year before. But it raised its dividend in both years. I think its business model of buying up old wells remains unproven. There is a risk that its dividend will be cut in future.
Hunting for quality
So, if not just focussed on yield, what would I look for when putting my passive income plan into action? I zoom in on a company’s likely future ability to pay dividends. Does it have some competitive advantage in an area I expect to see continued strong customer demand?
If the answer is yes, I would consider the share price. After all, even a great company can make an unrewarding investment if I pay too much.
As an example, I think Judges Scientific has an excellent business model. But its current share price makes it too richly valued for my tastes. The current share price means Judges has a dividend yield of under 1%.
I’m excited about 2023
What makes 2023 potentially a brilliant one for me to take this approach though? I am excited about 2023 because a lot of blue-chip shares have high yields right now. With inflation at elevated levels, many shares have fallen and their yields have gone up.
In the next few years if inflation falls back towards normal levels, I would be surprised if we see so many blue-chip FTSE 100 shares offering yields of 6%, 7%, 8% and even higher. But right now, I can get yields like that for my portfolio!
Generating passive income
So having hunted for shares that meet my criteria, how can I start earning? My passive income plan is simple. I would put money into buying those dividend shares I have identified. That could be in the form of a lump sum, or by drip feeding money on a regular basis into a share-dealing account.
Either way, hopefully if I do that I can start to earn passive income. If I hold onto the shares, they may pay me dividends not only in 2023 but far into the future.
