Building a passive income stream can be done in several ways. However, most methods require a lot of effort. For example, investing in a buy-to-let property can be lucrative but also comes with a lot of hassle. That’s why I’ve always found investing in dividend shares to be a far more favourable approach that can still be highly rewarding.
Buying stocks and shares of dividend-paying businesses obviously comes with risks. And a poorly chosen investment can quickly destroy wealth rather than create it. With that said, let’s explore how I’d go about building a passive income stream with only £15 a week.
Buying in bulk
£15 is obviously not a lot of money. And chances are that if I tried to invest such a small amount each week, most of my capital would be gobbled up by commission fees. Here in the UK, the average transaction cost among brokers is around £10. And while commission-free trading platforms are available, these typically have a lot of hidden costs.
To solve this issue, I’ll let my capital accumulate. After three months, I’ll have a decent lump sum of £180 ready to invest. By taking this approach, the number of transactions drops significantly, and most of my capital isn’t spent on broker fees. That means more money is being put to work in generating my passive income stream.
Avoiding yield traps
With enough money saved up, the next challenge is picking which companies I want to invest in.
A common mistake is to go for the firms with the highest dividend yields. While there are a handful of companies out there capable of paying and maintaining double-digit yields, most can’t. And this mistake often leads investors astray, buying shares in a business right before dividends get cut.
It’s important to understand that dividend yields can increase in two ways. The first and most desirable is when management announces business is going well and more capital is being returned to shareholders. The second is if the stock price tumbles. The latter situation is often what generates double-digit yield traps. And it’s why before committing to any high-yield investment, I look at how the share price has performed recently.
Building passive income over the long term
On average, the FTSE 100 has historically offered a yield of around 4%. However, building a diversified portfolio that returns around 5% in dividends is achievable by being more selective.
At a rate of around £15 a week, I can expect to make approximately £39 passive income in my first year. That’s certainly not enough to retire on. But over the long term, it might be. Thanks to compounding, after five years, £39 becomes £480. After a decade, it’s close to £2,120. But after 30 years, my tiny weekly investment transforms into an annual passive income of £28,335!