For me, the most convenient way of generating passive income for life is buying shares that pay dividends. But choosing the right shares can be tricky.
Some of the businesses behind stocks are not suitable for a long-term approach to investing. If I pick the wrong shares, dividends could dry up later on. And sometimes a poor dividend performance can lead to a bad share-price performance.
So my strategy aims to avoid stocks that can’t deliver a reliable and enduring stream of shareholder dividends.
The wonderful few
And legendary long-term investor Warren Buffett demands high standards from his stocks as well. He reckons the market is made up of many companies with low-grade and mediocre businesses. But there are also a few exceptional ones.
And the excellent businesses he targets tend to work like money compounding machines. They likely increase their revenues, earnings and cash flow on average each year and spit out an ongoing stream of rising shareholder dividends. He calls such beasts “wonderful” businesses.
So my plan is to find Buffett-style wonderful businesses. Then I try to buy some of their shares at opportune moments when the valuation makes sense of a long-term investment.
But having bought shares like that, I then need to decide what to do with the dividends that keep arriving in my share account. And those dividends are passive income to me because I didn’t have to do any ongoing work to earn them. As long as I keep holding the stocks, and as long as the underlying businesses keep thriving, those dividends will likely keep on coming.
Building passive income potential
But I’m in the building stage of my portfolio, so I’m not taking the dividend money out to spend it. Instead, I’m reinvesting them back into the shares of wonderful businesses. And that’s because I want my gains to compound in value and become larger and larger over time. One day, I’ll switch to spending the dividends and, by then, I’m aiming for them to be larger than they are today because I’ve been compounding.
There’s nothing certain or guaranteed, of course. Even if I choose wonderful businesses I could still lose money. All stocks carry risks. But I reckon following the approach of successful investors could serve me well in the years ahead. And investing £5 a day in dividend stocks is a good place to begin.
The sum works out at just over £152 a month, or £1,825 a year. For the price of daily lunch out, I could be making a big difference to my financial future. And, for me, the best way is to invest that money every month. And I’d deduct it as an expense from my income before anything else. Then I’d put it in a tax-efficient ‘wrapper’ such as a Stock and Shares ISA, or a Self-Invested Personal Pension (SIPP). And within those accounts, I’d buy my stocks.