Passive income is money that comes in without needing work. The concept sounds attractive to me – but passive income ideas are not always as easy as I’d like.
I don’t fancy the potential hassle of setting up a drop shipping scheme or devising a digital course. Instead, I simply invest in shares.
Targetting £100 a month
Let’s say I wanted to earn £100 a month. That would need dividends of £1,200 or so a year. As dividend payment times vary, I’m talking about £100 as a monthly average, not a payment of £100 each and every month.
The FTSE 100 yield has hovered around 3.5% on average over the past couple of decades. At that rate, I’d need to invest around £34,000 to generate £100 of dividends per month. That is quite a large capital outlay upfront.
However, some shares offer a higher yield than this average. By investing in such passive income ideas, I could try to generate £100 a month using less capital upfront.
Balancing risk
Sometimes, shares offer a high yield for a reason. Maybe the market doesn’t think they can sustain their payout levels, for example.
When picking my passive income ideas, I wouldn’t just focus on historical dividends. I’d look at what I thought a company could pay in future. Additionally, I’d seek to diversify across different companies and sectors.
High-yield tobacco
Tobacco shares often have high yields. Partly that reflects the strongly cash generative business model. But I think it does also point to concerns about the durability of customer demand. Lower cigarette sales risk smaller revenues and profits.
I’d still pick British American Tobacco for my passive income stream, though. The company offers a strong brand portfolio, massive cash flows, and a progressive dividend policy. It currently yields 7.6%. So putting in £6,150 should generate almost £39 of dividends per month for me.
Financial services
Next on my list of passive income ideas is financial services name M&G. The well-known financial services brand grew its dividend this year. With a yield of 7.7%, £6,150 invested in M&G shares would give me a prospective yield of around £39.50 monthly.
One risk is any financial downturn, which could reduce demand and profitability in the business.
Passive income ideas on my shopping list
My third passive income idea would be supermarket operator Tesco. At 4.3%, its dividend yield is lower than my other two choices. That would still come out to about £22 a month on average from dividends.
Tesco has the largest market share of any UK supermarket. As well as an extensive store estate, it has been building its online operation rapidly. But an intensely competitive market risks lower profit margins in future.
Putting my passive income ideas into action
For £18,450 today, I could set up a passive income stream equivalent to £100 a month. What’s more, I only need to pay once for the shares. But if the companies keep paying out dividends in future, my passive income stream could continue indefinitely.
Dividends are never guaranteed, though. There is a risk that they could be cut or cancelled. Imperial cut its last year, and Tesco stopped dividends for several years before restarting them in 2018.
Dividends are often paid quarterly or biannually, so I wouldn’t expect the passive income to be received every month. If monthly timing is important, I could set up a passive income stream designed around that objective.