The concept of passive income sounds straightforward – generating money without having to work for it. In practice, I try not to overcomplicate my own passive income streams. That is why I focus on investing in UK dividend shares.
If I had £1,000 to use in this way right now, here is how I would go about it.
Lifelong focus
I would start by asking myself what sorts of companies I reckon might still be producing income and paying dividends for years to come. Then, as I may not get my answer right, I would split the £1,000 evenly between four of them. That way, even if one of the businesses runs into hard times and reduces or cancels its dividend, hopefully I will keep receiving some passive income from the others.
If a share pays dividends, I should receive them for as long as I hold the shares. So for example, if I buy shares today in a company like Shell or British American Tobacco, if they continue to pay dividends in future I will still get some money from them long after I invested my £1,000. Dividends are never guaranteed, which is why I would spread my choices.
But with £1,000 I need to be realistic about what to expect. If I hold shares with an average dividend yield of 5%, I would hope to earn around £50 a year in passive income.
Dividend shares to buy now
So how would I find the sorts of shares I am talking about? First, I would consider what markets are likely to continue existing decades from now. For example, no matter what else happens in the economy, I expect there will still be demand for housebuilding and consumer goods. I feel the same about insurance and healthcare.
Then I would look within such durable industries for companies that have some sort of competitive advantage. In consumer goods, for example, Diageo owns a wide variety of premium drinks brands such as Johnnie Walker and Guinness. Those brands offer a competitive advantage I think can last – other brewers may offer stouts or porters, but only Diageo owns the Guinness brand name.
Such competitive advantage matters because it gives a company pricing power. That can help it make profits. Profits make dividends possible.
Setting up passive income streams
Once I had identified the sorts of dividend shares I felt fitted my goal, I would invest the £1,000. I would put £250 into shares of four such businesses, making sure I spread my choices across different business areas.
To do that, I would use a share-dealing account or a Stocks and Shares ISA. Although passive income is my goal now, if I decide at some point I do not need it, I could choose to reinvest the dividends rather than receive them as cash. That could help me grow my portfolio. Over time, that could lead to bigger passive income streams.