Making money without working for it is a simple idea. Such earnings are known as passive income and lots of different people have their own ideas about how they might seek to generate it.
My preferred approach consists of buying shares in blue-chip companies I think may pay dividends to me in future. Dividends are basically a way for a company to distribute some or all of its spare cash, by dividing it up among shareholders.
Here’s the appeal!
Why do I like that approach to earning passive income? This strategy really is passive – I can sit back and do nothing but still earn the money.
It lets me benefit from proven, profitable businesses rather than trying to reinvent the wheel. I can also tailor such a plan to my own financial circumstances.
For example, if I had a spare £9,000 and wanted to target £530 of passive income a month on average by owning dividend shares, here is the approach I would take.
Get ready to buy
As owning dividend shares is core to my passive income plan, I would need a way to buy them. So I would start by setting up a share-dealing account, or Stocks and Shares ISA.
I would then put the £9,000 into it, ready to use when I found shares I wanted to buy.
Picking shares
But how would I do that? I would look for what I thought are great companies with long-term potential to generate sizeable amounts of spare cash.
So I look for things like a sustainable competitive advantage, a large target customer market and a healthy balance sheet.
Not all companies use spare cash to pay dividends. They may invest it in growing their business, for example. So I look for companies I think can do that, but will also likely pay dividends over the next several years.
Putting theory into practice
What is an example of such a company? Consider Legal & General (LSE: LGEN). The financial services provider operates in a pensions market I expect to experience substantial, ongoing demand. Its well-established brand, large customer base and deep experience are all strengths, in my opinion.
When looking for shares to buy I hope can earn me passive income, I also consider what might go wrong. For example, in the 2008 financial crisis, Legal & General cut its dividend as turbulent markets hurt stock market returns. The same could happen again. Dividends are never guaranteed.
If I had spare cash though, I would be happy to add Legal & General shares to my portfolio. It would only be one of my picks though. I always spread my risk by diversifying across a range of shares.
Aiming for a target
Legal & General currently has a dividend yield of just over 8%. Investing £9,000 at an average yield of around 8% ought to earn me £720 in passive income annually.
That would be welcome, but is far off my target. If I could reinvest my dividends and so compound my portfolio value, after 29 years, an 8%-yielding portfolio should be earning me an average monthly passive income of £530.
I could start generating passive income on a smaller scale far sooner if I wanted, by not compounding my dividends.
This post was originally published on Motley Fool
