The thrill of passive income is money coming in without having to work for it. But, like many thrilling ideas, it can be hard to bring to life.
My own approach is to keep things simple. Large companies with proven business models can often make consistently big profits. By buying shares in them, I hope to receive some of those profits in the form of dividends. They form passive income streams.
Such an approach does not require a lot of money upfront. In fact, I could put it into action with a fairly modest sum each day. Here is how I would go about that using £8 a day.
Saving regularly
I could start with a lump sum if I had one.
But I think there is a benefit to regular, structured saving. It will help me get into the habit of putting money aside in a disciplined fashion.
Putting aside £8 a day means I would save £2,920 each year to invest with the aim of earning passive income. To do that, I would use a share-dealing account or Stocks and Shares ISA.
Choosing dividend shares to buy
Not all companies pay dividends. Those that do choose how much to pay out. On top of that, dividends are never guaranteed even if a company has paid them for decades already and is profitable.
With my focus on buying shares to generate passive income, what does all that mean?
First, I do not focus too much on what a company’s dividend history is but rather try to choose shares based on what I think their future dividend potential is. Secondly, I diversify by spreading my money across a selection of different shares.
Looking at dividend potential
That may sound well in practice, but how do I decide what shares I think have strong dividend potential?
Basically I look for a company that has a strong business and no strong need to reinvest all its profits. So if the business has a competitive advantage in an industry I expect to see strong future demand and does not need to plough the money back into growth or costly expenditure like developing new markets, it would be a candidate for my portfolio.
As an example, discount retailer B&M has a proven retail formula, a loyal customer base and could cut right back on expenditure if necessary by keeping its stores in less-than-perfect condition. For a discount retailer, a gleaning shop is not most customers’ priority.
Growing passive income streams
At its current share price, B&M has a 3.5% dividend yield. That means that, if my first year’s savings of £2,920 were invested in B&M and other shares with the same yield, I ought to earn slightly more than £100 in dividend income.
Other shares have a higher yield, so depending on my choices I could hope to earn a bigger passive income. If I choose well, hopefully the dividends of shares I own will rise over time (though the reverse can also happen).
If I take time to choose great companies when their shares sell at attractive prices, hopefully I could turn my daily £8 into growing passive income streams.
