Passive income ideas come in all shapes and sizes. One of my personal favourites is buying shares in blue-chip FTSE 100 companies.
I like that for a few reasons. I can start without a lot of capital. The approach can be tailored to however much spare money I happen to have. Owning shares is genuinely passive (some passive income ideas actually end up involving a lot of work as far as I am concerned).
Not only that, but owning shares could possibly earn me more every year, even if I do not buy any more.
Dividend growth
That is because of the potential for companies to increase their dividends.
A dividend is basically a tiny portion of a company’s profits that it pays to its shareholders. To see how this can work, consider brewer and distiller Diageo. Its brands such as Johnnie Walker and Guinness are unique. That gives the company pricing power, meaning it can hopefully grow profits over time. Last year, Diageo made a post-tax profit of £3.4bn.
Long-term profit growth can help a company increase its dividend regularly. Diageo is what is known as a Dividend Aristocrat, meaning it has raised its dividend annually for many years. If I had invested £1,000 in Diageo a quarter of a century ago, my passive income from that investment would have grown every year since.
Spotting good dividend shares
But while we know that now, 25 years ago nobody knew what would happen to the Diageo dividend. No dividend is ever guaranteed, even if a company has a long history of regular raises. After all, to keep increasing the dividend a company typically needs its profits to go up not down over the long term.
When buying dividend shares in the hope of earning passive income, I aim to build a diversified portfolio of different companies. But just buying different shares is about reducing my risk, not improving my opportunities. For that I need to choose carefully in the first place whenever I buy a share (or decide to sell one).
I would be on the lookout for companies that had some unique competitive advantage I thought could help them do well in a market I expect to see strong demand in the future.
Not only that, but I would look at the company’s balance sheet too. If it is too weighed down with debt, that could eat into a company’s ability or willingness to pay dividends, even if it is profitable.
Setting up passive income streams
Buying dividend shares costs money. I could either use a lump sum, or make a regular contribution to a share-dealing account or Stocks and Shares ISA.
Either way I need to be realistic about my expectations. If I invest £5,000 at an average dividend yield of 7%, for example, my passive income in the first year ought to be £350. But my shares could underperform so I might not achieve that.
Yet hopefully, if I have chosen the right shares, over time my dividend income would grow — and keep growing!
