Earning income without working for it sounds like a great idea – but is it practical? I think it can be, depending on what passive income ideas you use.
I try to earn extra income by investing in dividend shares. Here is how I would use that approach to try and build a monthly income of £1,000, which adds up to £12,000 each year.
Targeting an annual £12,000 passive income
How much would I need to invest to try and reach my target?
That depends on the average dividend yield of the shares I buy. A dividend yield is the money I would hopefully earn annually from a share expressed as a percentage of what I pay for it. At the moment, I think I could realistically target a 6% average yield while limiting my purchases to blue-chip companies. Indeed, some dividend shares I own in my Stocks and Shares ISA, such as M&G and British American Tobacco, currently offer a yield of 6% or more.
At that rate, to earn £12,000 in passive income each year I would need to have an investment pot of £200,000. Saving at a rate of £175 a month, that would take 95 years!
But could I speed things up? I think so. Simply by reinvesting my dividends rather than taking them as cash each year, I should hit £200,000 in 33 years. That is because of the principle of compounding.
Thirty-three years is still a long time. But it is nowhere near 94 years! If it will take me 33 years to hit my target, though, the sooner I start the better.
Choosing UK shares to buy
In the example above, I presume that share prices and dividends are constant. In practice that is unlikely. They could go down – but they might also move up, helping me hit my target earlier.
Still, this passive income plan is likely going to take me decades. So I need to choose the shares with the mindset of a long-term investor. I am not just looking for shares in businesses that are performing well today. I would try to buy shares in companies I expect could do well for decades to come.
Nobody knows what the future may bring even for the best run companies, which is why I would diversify my portfolio across a range of shares. Nonetheless, some companies seem likely to benefit from long-term demand and their own pricing power, in my opinion. For example, Unilever and Legal & General are two companies I would consider owning in my portfolio on that basis. Indeed, I have already bought Unilever shares and receive passive income from them every quarter.
Lifelong income
Putting this plan into action to hit my target could certainly take a long time. Then again, I think it could really be worth doing. An extra thousand pounds every month in passive income would certainly come in handy as I get older.
If the companies I invest in keep paying dividends, my income streams should continue for as long as I hold the shares – potentially the rest of my life. I would try to find businesses with strong prospects for profit growth that can increase their dividends. That way, I may actually find that over time, my annual passive income gets higher and higher.