Is it really possible to earn money without working for it? The answer is a resounding ‘yes’ – by owning dividend shares to create a passive income stream.
I think I could earn £300 of passive income each month by investing long term in dividend shares. And here is how, in three steps.
1. Start putting money aside regularly
The heart of my passive income plan is investing money in shares and earning dividends. I could do that by starting with a lump sum today. To earn £300 each month in dividends by investing in shares with an average yield of 5%, I would need to invest £72,000.
Even starting from scratch, I could build it up the level of investment over time by saving regularly. Doing so would take longer to hit my monthly target, but if I save for long enough, I could reach my goal over time.
I think the discipline of regular saving is essential to my plan, even when other spending priorities pop up. So I would set up a regular standing order to pay into a share-dealing account, or Stocks and Shares ISA. I could then start investing and earning dividends in the short-term, building slowly, even if I had not saved nearly enough to hit my target yet.
2. Find dividend shares to buy
Next I would need to find shares to buy. To reduce my risk if any one business does not perform as expected (which is more common than many investors like to admit), I would diversify my investment across different companies operating in a variety of industries.
Dividends are basically a form of profit sharing. So as dividends are my investment objective, I would look for companies I thought had a good chance of making big profits in future. To do that, I would hunt for businesses with a competitive advantage in an industry I expect to be around for a long time.
For example, I think the Greggs brand sets it apart among bakeries, while Twinings owner Associated British Foods has unique relationships with growers that a competitor may find hard to match.
But if I want to target a high dividend income, the price I pay for a share matters. The higher the share price, the lower a company’s dividend yield becomes. Greggs and ABF both yield between 2% and 3%, which, for me, are not attractive enough. So I would likely continue my search for high-quality companies with higher yields, like 6.3%-yielding Vodafone, or 4.7%-yielding Lloyds.
3. Put my passive income plan in action
Once I had found shares I felt were right for me, I would buy them for my passive income portfolio. Then I would sit back, keep saving regularly and occasionally buy more shares, although trading frequently adds costs and risks.
But If I do a good job in the first place by choosing great businesses I can buy with an attractive dividend yield, I would likely hang onto them in the hope of strong future dividends – and passive income!