Even when working hard for a wage, passive income can come in handy. Money that one receives without having to labour for it can be used to help with everyday expenses, or fund occasional splurges.
One of my favourite passive income ideas is investing in dividend shares. Here is how I would do that to target average monthly incomings of £300.
What are dividend shares?
Some companies that make profits use them to pay dividends to shareholders. So if I buy even just a single share in a company and it pays dividends, I will receive them based on the size of my holding. Something I particularly like about dividend shares is that if the company keeps paying dividends, I will receive them for as long as I hold the shares. So money I invest today could still be generating effortless earnings for me 10, 20, or even 30 years from today.
Dividends are never guaranteed and even successful companies sometimes cut or cancel a dividend they have paid for many years. To reduce that risk in my plan, I would diversify among different companies and business areas.
Doing the maths
Figuring out how much passive income I would receive depends on what is known as the dividend ‘yield‘. That is basically the percentage of today’s purchase price I would expect to receive as income per year at the current dividend rate.
For example, the yield on BP is 3.9% at the current share price. So if I invested £1,000 today I would hope to receive £39 of dividend income in a year. The Vodafone yield of 6.2% means £1,000 invested in the telecom giant’s shares would hopefully earn me £62 of dividend income in the following year. Over time, if dividends increased I may earn a higher yield based on my purchase price today. The opposite could happen, though, if a company cuts its dividend. Both BP and Vodafone have done that in the past few years and could do it again in future, for example, if their profits decline.
£300 a month of income is £3,600 in a year. So if I bought shares that yielded around 6% (similar to the Vodafone yield), I would need to invest £60,000. For shares that yielded roughly 4% (like BP) I would need to invest £90,000. In each case, I would be targeting an average yield from a diversified portfolio of shares.
How I would start building my passive income
£60,000 is a lot of money to invest. But I could hopefully hit my target if I invested that amount in shares yielding around 6%. A number of FTSE 100 shares yield 6% or higher, including Rio Tinto, M&G, Direct Line, Imperial Brands, British American Tobacco, and Vodafone. But not all may fit my risk tolerance. Although income is my objective here I would also consider the prospects for long-term share price gain or falls. There is little appeal for me in earning passive income from a company if its falling share price ends up costing me more than the dividends I received.
So I would do research into the right portfolio of dividend shares to meet my passive income objectives and risk tolerance. Then, I would begin investing through a Stocks and Shares ISA. I do not need £60,000 to start – I could actually begin with much less, if I was willing to accept a smaller monthly income than £300.
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Christopher Ruane owns shares in British American Tobacco and Imperial Brands. The Motley Fool UK has recommended British American Tobacco, Imperial Brands, 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.
