In the 1987 movie Wall Street, Gordon Gekko famously says that “money never sleeps”. I’m not sure if Gekko was thinking about passive income when he said that, but these words certainly ring true for me.
My portfolio of dividend shares continues to produce income through the year, even if I ignore it altogether. I’ve been following this approach for years. But today, I want to explain how I’d start a passive income fund from scratch with just £150 a month.
How I’d invest
To invest a small amount each month, I’d use a regular investment service. Many popular brokers now allow monthly investments as small as £25. If I was investing £150 each month, I could theoretically buy six shares at £25. In reality though, I might not do this, as I’d want to minimise the fees I was paying.
For example, if I was paying a trading fee for each stock, I’d probably buy two stocks each month, putting £75 into each. After three months, I’d switch my regular investment to two new stocks. And so on.
By the end of the first year, I’d have eight different dividend stocks. After two years, I’d have 16. I generally aim for a portfolio of 15-20 stocks, so I’d then be in a position where I could start buying more of the shares I already owned.
Turbo charging my passive income
After the first year, I’d expect to see a regular stream of dividends arriving in my Stocks and Shares ISA. What I’d do then is to start using this dividend cash to buy more shares, in addition to my regular monthly investments.
Reinvesting dividends can be a powerful way to build wealth. By doing this, I’d be using today’s income to buy extra income in the future. Over time, this technique — known as compounding — can deliver big gains.
Warren Buffett once said that “the stock market is a device to transfer money from the impatient to the patient”. When he said this, I’m pretty sure that he was thinking about compounding.
Shares I’d buy for passive income
What kind of stocks would I buy for my passive income portfolio? I’d start by focusing on the FTSE 100, because these larger companies are well-established and usually offer some of the highest yields on the market.
One of the main risks with a passive income strategy is that dividends will be cut. As we saw last year, this can happen anytime, for a variety of reasons.
To try and provide some protection against future dividend cuts, I’d look for payouts that were comfortably covered by earnings. I’d also aim to build a diversified portfolio, without too many cyclical stocks. That way, even if I had a bad year (like 2020), I’d still expect to get some income from my portfolio.
Looking at the market today, I’d probably focus on sectors such as consumer goods, insurance, defence, technology, and utilities. My aim would be to find businesses with pricing power and stable long-term prospects.
I’d be more careful about cyclical sectors, such as housebuilding and mining, which have enjoyed booming market conditions in recent years. The good times may not last forever.
Once I’d made my choices, I’d leave my portfolio alone, just checking in occasionally to reinvest my dividends.