Should I use some spare money to try and set up passive income that will hopefully last into the future? Put like that, the idea sounds appealing. Yet many people dream about these streams without taking any action to make them a reality.
Here is how I would invest £50 a week to try and target an ongoing flow of dividends down the line.
Bit by bit
£50 a week can soon add up. In the course of a year, it would give me £2,600 to invest. I could use this money to buy shares in companies that pay dividends.
Dividends are basically a tiny slice of profits a company pays to the owner of one of its shares. So the more shares I own in a firm, the more dividends I should receive if it pays them.
How do I know if a company will pay dividends in future? The answer is that nobody knows for sure whether a firm will pay dividends in future. Sometimes a company that did so in the past stops doing so, for example because its business performance has changed. So I usually study the company’s business model and decide whether it looks like it could produce surplus profits for years to come.
Choosing dividend shares
For example, retailer Tesco has a large store network, big customer base and well-known brand. I think that could help it make profits and pay dividends for years to come. But I may be wrong – back in 2014 an unexpected accounting scandal led Tesco to stop paying dividends for a while. That is now history, but illustrates the point that even an attractive-seeming company can suddenly disappoint on the dividend front. That explains why I would diversify my passive income streams across a range of dividend shares from a variety of industries.
I would focus on blue-chip companies I thought had robust finances and would likely continue to do well for decades. Sometimes it can seem tempting to invest in more speculative companies that seem to offer unusually high dividends. But as I am focussed here on setting up passive income streams for the long term, I would try to limit my risk. So I would only buy shares in companies I felt I understood, which matched my own risk tolerance.
Passive income target
How much would I need to invest to target £1,000 a month in passive income?
The answer to that depends on the average dividend yield of the shares I bought. Yield is basically the annual dividend expressed as a percentage of what I pay for the shares. For example, a 5% yield means that for every £100 I invest I would hopefully receive £5 in dividends each year.
I reckon I could target a 7% average dividend right now. That is above the FTSE 100 average, but companies I would happily invest in like Legal & General yield around the 7% mark. Investing £50 a week for a year in shares yielding 7% would hopefully generate income of just over £180 per year in future.
Over time, as I keep investing £50 per week, I ought to see my passive income rise. I would own more and more shares and hopefully that would equate to growing dividends.