The idea of earning money without working for it is understandably popular. This is known as passive income. It may sound like a pipe dream, but a common and practical way to earn such passive income is investing in shares that pay dividends.
To illustrate this, here is a detailed description of how I would go about investing £300 a month into dividend shares if I wanted to target an average £2,000 each month in extra income.
Saving regularly
I am using £300 as an example, but actually the approach could work with any amount. Investing more or less will quicken or slow the speed at which I could hope to hit my target though.
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What I think matters is setting an amount that is achievable, given my own financial circumstances and then getting into a disciplined, regular saving habit.
To do that, I would set up a share-dealing account, or Stocks and Shares ISA.
Buying dividend shares
The cornerstone of my plan is buying shares that I hope will regularly pay me passive income in the form of dividends.
That income would come in the future, of course. So I would not simply look at the dividend history of a company to decide if it looked suitable for my approach. Rather, I would try to find great companies with healthy balance sheets I thought might be able to generate substantial amounts of surplus cash in future and use it to pay dividends.
For example, consumer goods firm Unilever owns premium brands that give it pricing power. It operates in an area I expect to see high future customer demand. So it can hopefully keep generating a lot of excess cash it can use to pay dividends.
Spreading my risks
But what if Unilever comes a cropper, for example, because cost inflation eats into its profits?
Even excellent companies can run into difficulties. As a long-term investor I think in years or decades. On that timeframe, it is not just possible that some shares I own could go through a bumpy patch, but I regard it as likely.
Of course, I would still make effort to select high-quality companies with attractive share prices to build my passive income streams. But I would also make sure I am diversified across a range of such firms.
Building up to my target
Over time, hopefully my passive income streams would grow. Not only would I keep investing regularly, but I could also reinvest the dividends. That is known as compounding and could help me build my future dividend income faster.
This is a long-term project though. Imagine I invest in shares with an average dividend yield of 5%, for example. Even if I compound dividends, it will be 42 years before I have a big enough portfolio to generate my monthly target of £2,000 in monthly passive income.
That is a long timeframe. But along the way I could build a disciplined saving habit, learn about successful investment, increase the size of my portfolio and, hopefully, grow the regular dividend streams over time. If I decided not to compound them, I could start using those dividends as passive income in my day-to-day life.
