One of my favourite ways to earn passive income is by owning dividend shares. Earning a steady stream of payouts without sacrificing my time is a real pleasure.
But there are a few things to consider. So let’s investigate further.
Growing income
I could earn passive income by putting my money in the bank, of course. Recent hikes in interest rates now mean investors can earn around 5% a year on their cash by stashing their money for a year. But what makes income from stocks far superior in the long run?
Owning a basket of quality FTSE 100 shares offers two things that a savings account doesn’t. First, dividend payments can grow over time. As earnings climb, company management can distribute excess profits to shareholders in this way.
Second, share prices can rise over time too. More profits and opportunities can lead to a larger business.
But owning shares does involve more risk. Profits aren’t guaranteed, and businesses can suffer setbacks. They’re also run by people, and people can make mistakes.
That’s why I aim to diversify my portfolio and spread my investments across different sectors and industries. After all, I wouldn’t want to put all my eggs in one basket, even if it’s a basket of quality dividend shares.
How much do I need to start?
Earning £450 a month adds up to £5,400 a year. To get that amount of passive income, I calculate that I’d need to start with an investment pot worth over £65,000.
Alternatively, I’d need to invest £11,500 a year for five years to reach my target. This assumes during these years that I reinvest the dividends to buy additional shares. This effect is called compounding and it amplifies investments and dividends in the future.
It also assumes that I can grow my investment by 8% a year. As the FTSE 100 long-term average return, it’s a reasonable assumption to make (but again, not guaranteed).
Which FTSE 100 shares?
I’d focus on companies that have a proven track record of paying consistent and growing dividends. Many of these reside in the large-cap FTSE 100 index.
They can be big, established household names like BP, HSBC, and Unilever. But they also include relatively newer additions like B&M and RELX.
I’d build a diversified basket that also includes high-yield but slow-growth firms like Imperial Brands. Despite offering limited earnings growth, this Footsie share has an 8% dividend yield.
Owning a mix of these shares can give investors a chance to earn a reliable and growing passive income over time.
Bear in mind that I’d need to continue monitoring my choice of shares. Much can change with businesses. For instance, new competition or regulation can threaten a company’s business model, even if it’s a long-established firm.
Overall though, I find that earning passive income from shares can be a lucrative activity and I intend to continue doing so for years to come.
