Earning passive income is a goal for many investors. Having a consistent cash flow with minimal effort creates so many opportunities. Part-time hours, a less stressful job, or even early retirement — any of these ideas could become a reality with a sizeable second income.
My favourite way to approach this ambition is investing in dividend shares. This strategy doesn’t require big start-up costs, so I can get the ball rolling by saving small amounts regularly. In doing so, I’d harness the power of compound returns over decades, which is partly the secret to Warren Buffett’s ever-growing fortune.
Here’s how I’d target regular dividend income with just £100 a month.
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Saving and investing £100 per month equates to £3.29 per day. I think that’s a manageable target. In fact, it’s just 4p more than the average price of a latte.
So, by sacrificing the luxury of a daily coffee from a café, I could buy dividend stocks and secure a lifelong passive income stream instead. As a Foolish investor, I like that trade-off. Instant coffee it is!
But buying dividend shares on a daily basis with a few spare pounds isn’t necessarily the best strategy. That’s because I need to factor in additional charges, unless I’m using a commission-free broker like Freetrade.
Even then, the share prices of many high-yield dividend stocks are beyond my reach until I build up a more substantial sum. For instance, one company I own for its 7.5% yield is British American Tobacco, but the stock currently sells for £29.63 a share.
Accordingly, I’d invest at monthly intervals after carefully researching the dividend shares on my watchlist.
Compound returns
I’d aim for a 7% annualised return on my investments, including capital gains and dividend reinvestments. That’s broadly in line with the historic performance of major stock market indexes like the S&P 500, FTSE 100, and FTSE 250.
A well-chosen portfolio of dividend shares could deliver higher returns, but there’s no guarantee that will be the case. So, I’ve settled on 7% as a reasonable figure to use for modelling purposes.
The sooner I start investing, the better. Having a long investment horizon provides sufficient time for the magic of compounding to take effect.
| Year | Portfolio Value |
|---|---|
| 1 | £1,246 |
| 5 | £7,201 |
| 10 | £17,409 |
| 20 | £52,396 |
| 30 | £122,708 |
| 40 | £264,012 |
At only a 4% dividend yield, my portfolio would provide me with a five-figure passive income after 40 years — and I wouldn’t have to sell a single share.
Plus, while £100 a month may be a great starting point, if I could gradually increase my contributions over the years, the compounding effect would be even more pronounced. That would ultimately result in a bigger passive income stream down the line.
Risks
However, dividend investing isn’t risk-free. After all, companies can cut or suspend distributions, my returns may disappoint, and there’s always the possibility that a major stock market crash could decimate my portfolio, setting me back years.
That said, I’m an optimist for the long term. Diversifying my stock picks and an ability to stomach volatility are essential elements to mitigating risk and building a reliable passive income. With dedication and a sensible strategy, I believe I can achieve this starting with just £100 a month.
