Working hard to earn money is something millions of people do whether they want to or not. But many also earn money without working for it. That is known as passive income – such as dividends one receives for owning shares.
Here is a passive income plan I could put into action for just £35 a month.
Save a little, often
That much each month means putting aside slightly more than a pound a day. It seems practical to me, even if other unexpected bills pop up.
Over time, the monthly £35 will add up and form the basis of my plan. I will invest the money in shares that pay dividends. It will take me a few months to save enough that I can start buying shares without dealing fees eating into my purchases too heavily.
During that time, as well as saving, I would open a share-dealing account or a Stocks and Shares ISA. That way, when I am ready to buy shares, I could take action straight away. I would also take time to learn more about what sorts of shares might be good dividend choices for my passive income plan.
Learning about shares
There are lots of good resources I can use to learn about dividends and how to value shares.
Just because a company makes big profits does not mean that it will have a high dividend. For example, it may also have lots of debt that needs to be serviced instead of paying dividends. If the business does not enjoy a sustained competitive advantage, a new market entrant might hurt its profitability – and dividends. Past dividends are no guarantee of future payments.
So I would hunt for businesses with a competitive advantage in a market I expect to remain large. For example, I think people will keep buying alcoholic beverages, and Diageo has a brand portfolio that is impossible for a competitor to copy exactly. Similarly, I reckon customers will keep needing water for their homes and businesses. Severn Trent owns water assets that make it hard for other companies to compete cost effectively.
Dividends as the source of passive income
Having identified companies I could buy, I would buy shares in different ones. An unexpected turn of events could change even a strong business’s fortunes. Diversifying my portfolio across different businesses could help reduce my risk from any one holding.
How much passive income I could expect would depend on the average dividend yield of the shares I bought. By putting aside £35 every month, I would have £420 in a year. If I invested that in shares with an average yield of 2% like Diageo, I would expect £8.40 of passive income in a year. Investing it in shares with an average yield of 3.4% like Severn Trent, my prospective annual passive income from one year’s saving would be higher at around £14.
Long-term passive income plan
I could aim to boost my passive income by investing in higher-yielding shares. But I would never buy shares just because of their yield – I would always focus on their profit-making potential first.
Over time, as well as earnings dividends from newly purchased shares, I would hopefully continue to earn passive income each year from the shares I had bought before.