There are several ways to build passive income streams to earn some extra cash, from starting a business to becoming a landlord. But some of these methods either require a large starting sum or much time and effort.
One method that can be started with any amount involves buying shares. More specifically, I’d set up a passive income stream by buying and holding dividend shares.
Passive income from dividends
Dividends are a great way to earn regular income from shares, in my opinion. As an investor, I’d receive a share of a company’s profits. This means I should get rewarded if a business is successful and is able to grow its cash flow. That being said, not all companies pay dividends and those that do can stop them at any time. That’s why I try to carefully choose shares that have the best prospects to provide regular dividends.
But with thousands of available shares, how would I pick the most lucrative options?
First I’d consider the dividend yield. The average FTSE 100 share offers a dividend yield close to 4%. But I reckon I could find a selection of shares that offer slightly more. For instance, telecoms giant Vodafone offers a 6% yield and global miner Rio Tinto offers a market-leading 9%.
As an example, if I invested just £5 a day in both dividend shares, I calculate by the end of a year I could potentially receive a passive income of £137. Over time, I could increase my regular investment and grow my dividend income even further. On top of that, if the businesses perform well, the value of my shares could grow too.
Because all share prices can also fall, I try to invest for several years. By having a longer time frame, I’d hope to reduce the ups and downs of daily share price movements. As there are multiple risks involved with any one company, I’d also try to lower my risk by spreading money across a selection of shares.
Invest in what you know
One way to find shares is by a simple method popularised by successful investor Peter Lynch. One of his famous investment principles was “invest in what you know”. By observing the world around us, we can often see when a company might be showing promising signs. For instance, if I’ve just bought a new mobile and laptop from Apple, I might infer that this company could be doing well. Or if I find that I’m sending more parcels via Royal mail, I could realise that others might be doing the same. Further research would be needed but it can often make a good starting point. I could then read more about the company and its prospects.
By adding a small amount of new money every day, I don’t think I’d notice it. It’s just more than the price of a cup of coffee these days. Then by investing in a selection of dividend shares, I’d aim to build up this new passive income stream. Finally, I’d just need to decide what to spend the extra income on. I could always buy some more shares I guess. That could grow my dividend income even further. It’s called compounding, but that’s a lesson for another day.
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Harshil Patel owns Apple. The Motley Fool UK has recommended Apple and Vodafone. 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.
