Passive income can be elusive. In theory, all sorts of ideas to earn without working sound appealing. In practice, some work better than others (and some do not work at all!)
One proven approach to earning passive income is to buy a diversified range of shares in proven blue-chip companies that pay dividends. As dividends are never guaranteed to last, spreading the money across multiple shares helps manage that risk.
Here is the five-step approach I take to doing that!
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1. Being ready to buy shares
It can be frustrating to spot a great share to buy, without being able to do so. So I get my ducks in a row ahead of time by having a way to buy shares set up.
That might be, for example, a share-dealing account, Stocks and Shares ISA, Self-Invested Personal Pension (SIPP), or a combination of these.
2. Learning about the stock market
A great company might not make for a great investment. For example, maybe the business makes big profits, but has such high debt that it has to use them all to repay its creditors. Or it could simply be that the share’s valuation is too high.
So before investing (and on an ongoing basis) I take time to learn about how the market really works. That learning process never stops.
3. Finding shares to buy
My next step is to look for shares to buy. To illustrate, consider one I have bought this month, JD Wetherspoon (LSE: JDW).
The demand for pubs and hotels (Spoons operates both) is large. That could change as pub numbers are falling and I see that as a risk to overall customer demand.
But I think that might actually work to Spoons’ advantage. As a low-cost operator with a proven business model, it could pick up business from weaker competitors folding. The cost structure’s also threatened by large tax increases in the recent Budget. Indeed, that led to the publican’s share price falling, which is when I bought some shares.
Over time, I expect the company can pass higher input prices onto its customers. A large estate, proven operating model, competitive cost structure and economies of scale all help make me see the share price as offering good value.
4. Earning and (maybe) reinvesting dividends
With a 2% dividend yield though, I only expect to earn tuppence a year for every pound I put into Spoons shares at the current price.
Without changing my investment principles, I aim for a higher average yield from my portfolio. Reinvesting dividends initially can also help me build a bigger portfolio without raising my own regular contributions.
For example, if I invest £200 a month in shares with an average yield of 5% and compound the dividends, after 26 years I would earn an average monthly passive income of over £500.
5. Staying engaged
I could start earning sooner if I simply took the dividends as cash rather than reinvesting them. My approach is not to keep tinkering with the portfolio. I am a long-term investor, not a trader.
But as well as earning passive income, I would also keep an eye on its source, in case the investment case for any share I own changed in future.
