I reckon buying dividend shares can be a good way to set up regular passive income streams. It also doesn’t need to be expensive. Here’s how I would plan to start by using £10 a week.
Why I’d pick dividend shares
By buying dividend shares, I can benefit from the success of large companies without having to do any of the work. So I can put my money to work, hopefully earning me more, without needing to spend any time working.
Growth shares may increase in price, but often they don’t pay out dividends. So I may need to wait years until I sell them to get any capital appreciation in the form of hard cash. By contrast, dividend shares often make payouts annually, biannually, or even quarterly. So I should be able to benefit from such dividends within a few months of starting to invest.
That said, just like growth is never guaranteed, neither are dividends.
Is £10 a week enough?
If I could put in more than £10 a week, I would. That would help me increase my passive income streams faster. But I do think even £10 a week could set up meaningful passive income streams. It equates to over £500 a year. That is certainly enough for me to buy shares. Importantly, it allows me to reduce my risk by diversifying between different shares and industries.
On top of that, what some people forget is that if I buy shares today, I can keep getting any dividends they pay for as long as I hold them. So let’s say that this year, I invest £520 in shares yielding 5% on average. That will hopefully earn me £26 a year in dividends. But next year, I would still receive any dividends paid by those shares. So I could get £26 of dividends next year – on top of any more dividends on the new shares I purchase.
That means, after a decade of putting aside £520 a year at a yield of 5%, I’d be earning £260 a year in passive income. In reality, if dividends had grown during the decade, I might actually get a higher amount. On top of that, I would benefit from any capital appreciation due to share price rises. There is a risk, though, that my capital could fall if share prices did.
Choosing shares for passive income
How could I decide which shares to buy?
With relatively modest amounts at stake to begin, I’d focus on trying to preserve my capital. So I wouldn’t invest in small or very speculative companies. Instead, I would put my money in large, well-established companies with a proven business model.
I’d zoom in on “free cash flow”. That is how much excess cash a company throws off each year. In the long term, that is what helps fund dividends.
That would lead me to looking at companies such as Legal & General, British American Tobacco, and National Grid. They yield around the 5% average yield I used in my example above. Only National Grid is below 5%, at 4.6%.
Then I’d choose the shares which best fit my investment objectives and risk tolerance. What’s right for a different investor might not suit me, after all.
Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
