One common way to earn passive income is to start investing in well-known shares that pay dividends. These are payments a company makes to its shareholders. Simply by owning shares in, say, Legal & General and JD Sports, I regularly earn passive income without having to lift a finger for it.
Such an approach does not even need to be very expensive. In fact, it can be tailored to any budget. Here is how someone with a spare £3k could start investing like that.
What can someone achieve with £3k?
The scale of the passive income streams earned will depend on what shares the investor buys. Each company makes their own choice of what, if any, dividend to pay shareholders. They are never guaranteed.
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Imagine an investor spreads the £3k over a few companies with an average dividend of 5p a year for each £1 invested (what we call a 5% dividend yield).
By spreading the money across multiple shares, the risk is reduced that one bad choice would stop all the passive income flows.
That should produce £150 a year in passive income. For as long as someone owns a share, they are entitled to any dividends it pays. So investing the money today could lead to lifelong passive income streams.
Boosting the income
That £150 is an example, but the income could be higher. One way would be to invest in higher yield shares. But as dividends are never guaranteed, it can be a mistake to start investing in a company just because its current yield is high.
A smart investor looks at a business and makes a judgement about what they think future dividends might be. So in this example, I will stick with 5%. That is above the current average FTSE 100 yield but I think it is achievable in today’s market while focusing on quality blue-chip companies.
If the investor waited a decade and during that time reinvested (compounded) the dividends, they would have a portfolio generating £247 of passive income annually.
Finding the right shares to buy and hold
As an example of the sort of share an investor may consider, I would point to British American Tobacco (LSE: BATS). At 7.8%, its yield is actually well above the target I mentioned above. It also has an enviable record of annual dividend increases dating back decades.
That might not last, of course. Cigarette sales volumes are falling in many markets, threatening both revenues and profits for the Lucky Strike maker.
But it remains highly cash generative and has a portfolio of premium brands that give it pricing power. It is also rapidly expanding its non-cigarette business. I think the business can benefit over the long term from its global distribution network and manufacturing expertise.
Of course, some investors may shun British American on ethical grounds. Something I like about investing is that we can each make our own decisions.
Getting started
To start investing the £3k in whatever shares they choose, the investor would need some sort of dealing account. So it makes sense to look at some of the different share-dealing accounts and Stocks and Shares ISAs on the market and compare them.
