Passive income does not have to be complicated.
My own approach to earning money without working for it consists of buying shares in blue-chip companies like Vodafone and British American Tobacco (LSE: BATS).
That approach can be tailored to individual financial circumstances. If I wanted to target £700 in average monthly passive income, here are the seven steps I would take.
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1. Start saving regularly
I would get into a disciplined habit of putting aside a set amount on a regular basis.
The more I save to invest, the sooner I should hit my target. But I need to be realistic. In this example, I use a weekly contribution of £85.
2. Set up a share-dealing account
That money cannot be used to buy income shares unless I have a mechanism to do so. So I would set up a share-dealing account or Stocks and Shares ISA and start drip feeding money into it.
3. Learn how stock markets work
Next I would get to grips with some of the basics of investing.
For example, as dividends are never guaranteed but form the basis of my passive income plan, I would want to learn how to read company accounts.
I would also learn concepts like free cash flow, as my potential passive income is basically some of the surplus cash generated by blue-chip companies.
4. Decide on an investment strategy
Another move would be to decide how I would aim to achieve my goal.
With passive income as my target, I would be buying dividend shares rather than growth shares. But I would still have a few things to consider, before I made a move.
For example, British American Tobacco’s 9.5% dividend yield is high (indeed, among the highest for any FTSE 100 share). But its core business is cigarettes and demand is declining in many markets. On top of that there is a minefield of regulatory risks that could hurt future profitability.
So, I would need to decide what risk level I was willing to accept.
I might also consider whether I would shun some shares on ethical grounds. Using tobacco kills millions of people – and British American Tobacco has built its business around the habit.
5. Buy shares
Having set my strategy, I would next look for shares to buy.
Price matters even for dividend shares, as a falling share price could mean I ultimately lose money despite the dividends.
Over time I would build a diversified portfolio of income shares. I would look for companies with the sort of competitive advantage that gives them pricing power, like British American’s portfolio of premium brands does.
6. Earning and reinvesting income
I could start earning passive income fast in the form of dividends.
But, to hit my target faster, I would not do that straight away. Instead, I would reinvest my dividends (known as compounding) while continuing to add £85 a week of money.
7. Being patient
I would then stick to this system over time.
At a lower yield than British American’s – say 6% — I ought to hit my £700 monthly passive income target within 18 years. That yield is above the FTSE 100 average, but I believe it is achievable if I find the right shares to buy.
