Money I get without working for it sounds too good to be true. But that is the theory of passive income. In practice, some of my favourite passive income streams are shares that pay dividends.
If I had a spare £50 a month and wanted to set up such streams in three easy steps, here is the plan of action I would use.
1. Start saving £50 a month
I would decide how I was going to set aside my monthly sum of £50. For example, would it be cash I put in a piggy bank or a bank transfer? However I decided to set the money aside, I would want to make sure that I did so on a regular basis. Getting into the habit of putting aside the money to build my passive income streams would be important. That is because if I am disciplined about building the right mindset and habits when it comes to income, I think I am more likely to stick to my resolutions.
Although I would not start buying shares immediately, this would also be a good moment to set up some sort of share-dealing account. That way, once my monthly contributions start to pile up and I am ready to make my first share purchase, I will be able to do so.
2. Identify dividend shares I could buy
Share-dealing charges mean I would wait a few months to start investing, at which point I would have several hundred pounds. That way I could hopefully suffer less impact from any charges as a percentage of the amount I am investing.
I would put the time to good use, though. Specifically, I would start looking for dividend shares that might meet my own investment criteria. Not all shares pay dividends and even those that do can cancel them. So I would focus on the future prospects for a business. I would want to judge whether I thought it could generate enough free cash flow in future to fund and ideally even grow its dividends. A great source of information for this is a company’s annual report and accounts. These are usually available free online.
I would make sure that I did not concentrate too heavily on just one company or business area. For example, I like the high dividend yields of tobacco stocks. But if I put all my money into tobacco companies British American Tobacco and Imperial Brands I would be concentrating my risk. If new regulation threatened the profitability of tobacco products, I could see all my passive income streams dry up at once. So in choosing shares, I would diversify.
3. Set the passive income streams in motion
Then, as my funds grew and I decided what sorts of shares suited my objectives, I would start buying them. As an investor with a long-term outlook, I would likely keep them rather than trading frequently. That way I could sit back and enjoy the passive income.
At first, my investments would be fairly modest. £50 a month is £600 a year. The average FTSE 100 yield tends to be around 3% to 4% a year. So my first year’s investing would hopefully get me annual dividend income of around £18 to £24. But if I keep putting away my £50 a month, over time, hopefully my passive income streams would get larger.
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Christopher Ruane owns shares in British American Tobacco and Imperial Brands. The Motley Fool UK has recommended British American Tobacco and Imperial Brands. 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.
