One way to earn passive income is simply to put some money into carefully-chosen blue-chip shares then sit back and wait for them to pay dividends.
I say carefully-chosen because not all shares pay dividends and those that do can change their policy at any time. But with a bit of research, I think it is possible to set up passive income streams that could hopefully go on for years, or even decades.
I could begin with whatever spare financial resource I had. For example, if I had £3,000 I was willing to invest, here is how I would aim to turn it into weekly passive income of £30 over the long term.
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1. Getting prepared
My first step would be to get ready to invest. At a practical level that would mean setting up a share-dealing account, or Stocks and Shares ISA so I had a vehicle through which to buy shares.
I would also educate myself on some of the basics of how the stock market works.
For example, how could I try to separate companies with outstanding dividend prospects from the rest? How could I value companies? What sorts of red flags ought I to look for when considering the risks of any given investment?
2. Finding shares to buy
My next step would be to draw up a shortlist of shares to buy.
Even the best business can run into unforeseen difficulties, so I would diversify my holdings across a few different shares. With £3,000, I could buy a handful of different shares comfortably.
With dividends as my focus, I would look for a company I thought had strong future cash generation potential. But I would also consider how likely they seem to pay dividends.
For example, Google parent Alphabet generates huge cash flows – but it does not pay a dividend. Investing in Alphabet might be a smart move for me as an investor but, for now at least, I would not do so if my objective was passive income.
Free cash flows start with operating cash flows. That is the excess money generated by a business’s core activities. But other factors, such as financing and investment cash flows, can have a significant impact too.
A business might be bringing in loads of money but need to use it to pay down debt rather than pay dividends. So I also look at a company’s balance sheet for important information like its net debt position.
3. Aiming for an income target
How realistic is it for me to aim for a weekly passive income of £30 on average from an investment of £3,000?
In a year, that would mean earning £1,560 in dividends. That is 52% of my £3,000 investment. That suggests what is known as a 52% dividend yield.
It is almost unimaginable that a high-quality share would have a 52% dividend yield in anything other than exceptional circumstances.
But if I reinvest the dividends as I go, I could hopefully hit my passive income target over the long term. At an 8% annual return, for example, after 24 years, my initial £3,000 investment ought to be generating £30 on average in weekly dividends.
