An additional passive income would be helpful given the rising cost-of-living. That said, it can take some time to put a plan in place. But with planning and patience, it’s certainly possible.
One of my favourite ways to earn this kind of second income is from dividend shares.
Many FTSE 100 shares pay chunky dividend income to shareholders. Although the average yield is around 3.8%, many dividend shares offer over 8%.
That’s where I’d focus my search.
How I’d target passive income
Today, I’m looking at how to target a £4,000 annual passive income. Investing £300 a month would be a sensible starting point. But it won’t be enough to start earning my passive income amount straight away.
I’d need time. For instance, by diligently making this regular monthly investment over 10 years, I calculate that I’d potentially build a pot worth over £50,000.
That assumes I reinvest my dividends. By doing so, it has the magical effect of compounding my returns. This means I’d start to receive dividends from my dividends in a type of snowball effect.
By contrast, let’s consider what happens if I save £300 a month without investing it. Over a decade, it adds up to just £36,000. Not an insignificant sum, but still a great deal less than if I put it to work for me.
Going back to my £50,000 pot, after a decade if I wanted to, I could stop the monthly contributions and choose to withdraw the dividends instead of reinvesting them.
This should result in a £4,000 annual passive income.
What I’d go for
The above assumes I own dividend shares that offer an 8% yield. Such a yield isn’t guaranteed of course and I could also lose money. But to boost my chances of success, the stocks I’d go for right now include Legal & General, Aviva, Rio Tinto, HSBC and Imperial Brands.
These five FTSE 100 shares currently offer an average dividend yield of 8%.
But there are a few things to bear in mind. I haven’t picked these shares just for their yield. Several additional factors go into trying to pick suitable shares.
All five are established businesses. They have multi-decade track records of consistently distributing dividends to shareholders. Although this doesn’t guarantee future payments, it reflects a long-standing policy by management.
Another point to bear in mind is that dividends are typically paid from earnings. So I prefer to find companies that have relatively stable or growing profits.
Spreading the risk
Some industries like mining and banking are more cyclical than, say, consumer staples or insurance. That means earnings could be prone to larger swings in the former compared to the latter.
Owning a mixture of both types can help to diversify my portfolio and spread the risk. It avoids putting all my eggs in one basket. To reach my passive income goal, I’d need to be consistent and patient.
And despite owning shares in large, well-known businesses, I’d need to keep an eye on my holdings. Factors can change over time and other shares might prove to be better options.
