Earning a passive income is a common financial goal for investors. And while there are multiple ways to go about it, saving regularly and investing in dividend shares is my preferred method. While it can take some time to build up, saving as little as £20 a week is enough to get started, in my experience.
Saving regularly for passive income investments
One of the biggest barriers to entry into the stock market is the initial need for capital. After all, I need money to make money. Yet by saving regularly, this barrier can easily be overcome given time. Putting as little as £20 a week aside is enough to build up a pile of just over £1,000 a year. And that’s more than enough to start generating a passive income through investments.
Saving £20 a week can be a challenge depending on an individual’s financial position. But it can be achieved by sacrificing a few of life’s comforts, like pints at the pub or trips to the coffee house.
Avoiding the costs of investing
Buying and selling shares is not a cost-free process. Brokers charge a fee on each transaction that can quickly eat into investment returns if not handled correctly. Even platforms that claim to have commission-free trading still have substantial hidden fees. And in some circumstances, they can cost more than paying a flat broker commission.
So how can I avoid this problem? The answer is quite simple — trade less often. By investing in bulk, rather than small sums, the total number of transactions is lower, and brokers, in turn, take less of my saved-up capital.
But transaction fees aren’t the only expense to tackle. There is a far more sinister force at work… it’s called Her Majesty’s Revenue & Customs. Passive income from dividends and capital gains from investments are taxable. Yet, savvy investors can sidestep this entire expense by investing using a tax-efficient vehicle, like a Stocks and Shares ISA.
The risks of generating a passive income with stocks
The idea of seeing money magically appear in my bank account from dividends is undoubtedly exciting. But nothing is risk-free. And investments can go South, even those in large, well-established businesses. The pandemic-triggered market crash in March 2020 is proof of that.
By diversifying my portfolio, this risk exposure can be reduced. And by investing in companies that have multiple competitive advantages, the level of free cash flow is more likely to increase over the long term. That’s a critical trait since dividends, the source of my passive income, are typically paid out of a company’s free cash flow.
Getting started
Two passive income stocks with massive dividends that I’ve recently explored are Rio Tinto and Persimmon. They both have to contend with intense competition and pressure on profit margins. But so far, they seem to be staying on top. So, if I were building a passive income portfolio from scratch, these two stocks would definitely be where I’d start.
Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
