People adopt a variety of approaches when it comes to earning passive income. My own preferred approach is putting money into shares that pay me dividends. That does not involve any work for me, I can start without a huge lump sum and I can benefit financially from the hard work of successful companies.
Here is how I would do that if I wanted to target an average weekly passive income of £100, or £5,200 a year.
Why dividend shares?
Shares are basically a tiny stake in a company. When a company makes profits, it can keep them to invest in growth, like Amazon does. But it might instead choose to distribute them among its shareholders.
That is a choice for the company, although financial performance also matters. After all, dividends cost money.
So such payouts are never guaranteed, even from companies that have paid them regularly in the past. But I think that by spreading my investments across a range of blue-chip companies with strong proven profitability and ongoing commercial potential, I ought to be able to build dividend income streams.
Choosing shares to buy
But how would I decide what shares to buy? A mistake some investors make is just to focus on yield.
Dividend yield is the annual dividend paid by a company as a percentage of its share price. So if I invest in shares with a dividend yield of 5%, I could hit my £100 weekly target by spending £104,000 on shares. At a 10% yield, I could get the same passive income by investing the lower but still substantial amount of £52,000.
Why is it a mistake to focus on yield alone? Shares are not like bank accounts or bonds, with a set interest rate that is paid fairly reliably in normal times.
A dividend can go up and down based on a business’s financial performance and priorities. So just because a share has a 10% yield today (like M&G does, for example) does not mean that the dividend will be maintained.
Sometimes it will be though. Indeed, I hold M&G in my own portfolio. The asset manager raised its annual dividend this month.
So what I look for is the quality of a business. Does it operate in a market I think will see strong demand for a long time? Does it have some sort of competitive advantage that can help it build customer loyalty even if its prices are not cheap? Is the company’s balance sheet healthy enough that it can use profits to fund dividends instead of servicing debt?
Hitting my passive income target
When investing in blue-chip FTSE 100 companies with strong commercial prospects, I think an average yield of around 5% is realistically achievable in today’s market.
If I earn that average yield, I would need to invest slightly more than £100,000 to hit my target. If I did not have that sort of money, I could drip feed money into a Stocks and Shares ISA gradually and build the funds up over time. That way, I would hopefully begin earning at least some passive income within months. Over the years I also ought to get closer to my target income.
