Some passive income ideas seem far-fetched to me, while others need a lot of money upfront. That helps explain why I like investing in dividend shares. I can benefit from the success of proven businesses, without needing a huge cash pile to start.
Here is how I would go about that, using £250 a month.
Regular saving
Although building up a portfolio of dividend shares would not require a lot of money to start with, it will take some. I would generate that by setting aside funds on a regular basis. Putting £250 each month into a Stocks and Shares ISA, for example, would add up to £3,000 a year I could invest.
By putting my monthly £250 aside regularly, I think I can get into the saving habit. Rather than hoping to suddenly have a lot to invest one day as if by magic, I think regular saving could help me build my wealth over time.
Dividend shares as passive income ideas
But how would having an extra £3,000 each year in my ISA help me earn passive income? The answer lies in dividend shares.
These pay out some of a company’s profits to shareholders in the form of a dividend. For example, at the moment, Shell has a dividend yield of 3.8%. That means that, for every £100 I invest now in Shell shares, I would hopefully receive £3.80 in annual dividends. I would not need to do anything for this income. If the firm kept paying dividends in future, I could earn year after year from my single purchase of Shell shares.
But not all companies pay dividends. Some do, but then business circumstances can lead them to cancel, or cut, the payout. Indeed, Shell cut its dividend a couple of years ago for the first time in decades.
So I would diversify my purchases across a range of companies and industries. I would also take time to try and find shares I felt had strong income prospects for the future.
Finding shares to buy
I would never know for sure what a company’s future prospects are. But I would look for certain indicators I felt could suggest a company may be in a position to pay dividends down the line. For example, I would choose to invest in firms that looked likely to generate big profits and free cash flows in future.
Let me illustrate. I reckon owning unique brands like Guinness and Talisker could help Diageo make big profits in years to come. But its dividend yield is only 2%. To hit my target annual dividend income of £5,000 owning shares with an average yield of 2% would require me to invest £250,000. Saving £250 a month means that could take a long time.
So I would try and invest in shares with a higher yield, like 7.2%-yielding Legal & General. But whatever the yield, my main focus would always be whether I felt the firm had a business model that could generate sizeable future profits. Ongoing dividends could hopefully help support a passive income for as long as I held the shares.
Only once I had identified such shares would I then start looking at their yield. When I found some I liked I would start investing — and building passive income streams.