Passive income plans can come in all sorts of weird and wacky forms.
But the whole point of passive income is that should be (more or less) effortless.
Learning about a new business and setting it up does not seem passive to me. Nor is it guaranteed to generate income – in fact, it could eat up money instead of producing it.
So my own approach is based on a few basic principles – I want it to be passive and I want to have a strong chance of earning income.
Why reinvent the wheel?
Many businesses already know how to generate income.
In fact, they generate so much more income than they need for their own business needs that they give some of it to shareholders on a regular basis, in the form of dividends.
An example is Games Workshop (LSE: GAW).
At the start of June, it had £108m of cash and cash equivalents. Over the next six months, its operations generated £133m of cash. Even after spending on product development and sending a cheque to the taxman, Games Workshop divvied up £61m among its shareholders.
Yet it still ended the period with around £18m more in cash and cash equivalents than it began with.
In recent years, the FTSE 100 company has paid shareholders five dividends a year. All they need to do is spend money buying the share, sit back, and let the money roll in.
Taking a smart approach to income generation
But there are risks. Games Workshop’s concentrated manufacturing footprint means that if a key factory goes offline for any reason, sales could fall sharply. It plans a new factory in Nottingham, due to be completed next year.
Even a great, proven business can run into difficulties. So the savvy investor spreads money across multiple businesses to help mitigate the risk that one will do badly and reduce or cancel its dividends.
That does not necessarily take a lot of money – it is possible to buy shares even with a modest budget.
How much money could someone earn?
I use this strategy myself but I do not own Games Workshop shares, even though I think its fantasy universe and intellectual property are excellent competitive advantages.
Why? The share looks pricy to me.
It also has a dividend yield of 3.6%, meaning that if I invest £1,000 today I would hopefully earn £36 per year of passive income.
That is not bad: in fact it is in line with the FTSE 100 average. But I am earning much higher yields owning other shares, like 8.6%-yielding Legal & General and M&G, with its 9.5% yield.
Those are different companies to Games Workshop and each has their own risks as well as positive points. But by carefully selecting a diversified range of companies, I earn passive income from the hard work and proven business models of large blue-chip firms.
That need not be complicated.
An investor can start with how much they can spare, set up a share-dealing account or Stocks and Shares ISA then – having learnt something about key stock market concepts like valuation – start looking for income shares to buy.
This post was originally published on Motley Fool
