The attraction of passive income is that I get money without working for it. And a passive income streams I would use includes investing in a selection of dividend shares.
I think it is possible to do that starting with nothing and building up day by day. Here is how I would go about it.
Daily saving
To start in a manageable way, I would put aside £5 a day. That is around the cost of a pint or sandwich in some places, but it will soon add up. A fiver a day is £35 per week. So over the course of a year it comes to over £1,800.
When I start, I would also set up some sort of share-dealing account. One option would be a Stocks and Shares ISA, which would offer me some tax advantages.
Importance of diversification
To reduce my risk I would want to invest in a variety of companies and business sectors. That way, if one of them performed much worse than I hoped, the impact of that on my portfolio would be smaller than if I had not diversified properly.
So I would wait a few months before I started investing the money I was saving. I would have £500 in just over three months. I think that is enough to let me start investing in a diversified way, putting £250 each into two companies.
Choosing the shares
As my objective is passive income, I would probably focus on what are known as income shares not growth shares. There is no formal difference between them. But income shares typically pay out some or all of their profits to shareholders as dividends.
Dividends are never guaranteed, even if a company has paid them regularly before. So I would look for companies that generate high free cash flow. That is basically the cash coming in the door each year once all expenses are met. Ideally I would also look for companies with fairly low debt. Paying the interest on lots of debt, or repaying the capital, can eat into a company’s ability to pay dividends.
Two shares I could begin with
I could begin building my passive income streams with a couple of blue-chip shares. One is Tesco. Its dividend yield is currently 3.2%, so if I had £250 invested in it I would expect around £8 of dividends in the coming year. I like the company’s broad customer base and large store estate. But one risk is a shift to e-commerce that adds labour costs like delivery and could lead to lower profit margins.
Another share I would buy in my Stocks and Shares ISA is insurer Legal & General, which currently yields 6%. I like its iconic brand that helps attract customers. But any unexpected spike in claims (for example because of a freak storm) could hurt profits.
Watching the passive income streams pile up
As my objective is passive income, I could draw down the dividends regularly.
But once my income was growing, I would be tempted to let the dividends pile up in the ISA. That could increase my investment pot and would allow me to add more passive income streams for future.