Lots of people spend time and energy coming up with passive income ideas. But I like what I see as the straightforward approach of generating dividend income by buying blue-chip shares.
Such income is never guaranteed and I am careful in selecting the shares I buy. If I wanted to set about targeting a £10,000 annual stream of dividends, here is how I would go about it.
High yield versus high quality
Some shares offer small dividend yields, others have medium ones and a few seem to bring very high yields.
A common investor mistake is buying dividend shares for their high yields without understanding how sustainable the payouts are likely to be.
That can lead to a double whammy. A company cuts the dividend and its share price falls in response. Not only could that hurt my dividend income, it might also mean my shares are worth less than I paid for them.
That is why I always focus on buying shares in high-quality companies at attractive prices. If they also have a high yield, that could be good for my dividend income. But I try never to let the tail wag the dog.
Targeting £10,000
However, that order of priorities does not mean yield is unimportant. It is critical in calculating how much I would need to invest to try and hit an annual dividend income target.
For example, if I invest at an average yield of 5%, that goal would require me to invest £200,000. A 7% average yield would take nearly £143,000. If I managed to achieve an 8% average yield, I could earn £10,000 in dividend income each year with an investment fund of £125,000.
Drip-feeding funds
But what if I do not have that sort of money to spare? I could build up to my target gradually. For example, if I invested £200 each month at an average yield of 7%, after a year I ought to have a portfolio generating almost £170 in annual dividend income.
At that level of monthly contribution, I should hit my £10,000 annual target after around 59 years. That is a very long time to wait, although I could be earning growing dividend income along the way as my investment pot increased.
An alternative would be reinvesting those dividends, something known as compounding. If I compound annually at an average yield of 7%, investing £200 per month could let me hit my £10,000 yearly dividend income target after 24 years.
Selecting shares with dividend income potential
Some of the high-yield blue-chip shares in my portfolio such as British American Tobacco and M&G actually have yields higher than 7% right now. If I kept investing in a diversified portfolio of shares with those sorts of returns, I could potentially turn a monthly £200 investment into £10,000 of annual dividend income even faster.
But, crucially, I would also focus first on finding companies with strong business models and solid finances I thought looked likely to maintain or increase their dividends in future.
