The idea of earning passive income by buying dividend shares appeals to me for several reasons. First, it is genuinely passive – I can buy the shares and then benefit from any dividends they pay. Secondly, I see many large income payers like BP and Vodafone as leading firms in their fields.
Based on that, I think investing regularly in such shares could help boost my passive income streams. Here is how I would ultimately target £500 a month by investing £190 on a monthly basis.
Saving to invest
Putting aside money on a regular basis to invest in dividend shares could help me form a habit. That may be good as it could encourage me to keep saving each month even when other spending priorities reared their heads.
I would set up a share-dealing account or Stocks and Shares ISA in which to invest. But I need to be realistic about the relationship between how much I invest and the amount of monthly passive income I could earn. £190 a month would add up to £2,280 in the first year. If I invest that in shares with an average dividend yield of 6%, I would expect to receive monthly dividend income of around £11. That would be welcome – but is a far cry from £500.
To hit the higher number while investing £190 each month in dividend shares, I would need to be patient and invest over the course of many years. Even then, though, it could be a long wait. If the 6% average divined yield of my portfolio remained constant, I would need to wait more than four decades to hit my target.
The good news is that as I grew the amount of money I invested, then hopefully the monthly passive income would increase too even if it took a long time to hit £500. Still, could I try and reach my target faster?
Compound returns
I think I could, thanks to what is known as compounding. Basically, instead of taking out the dividends in cash, I would invest them straight back into more of the same shares. Like a snowball running downhill, in time the reinvested dividends would themselves effectively be earning dividends.
Thanks to that, in just 22 years, I would hopefully have a portfolio of shares worth over £100,000. With an average dividend yield of 6%, I should thus earn passive income of £500 each month.
In this example, I have presumed share prices and dividends remain the same over time. In practice, that might not happen. But the principle remains clear: compounding could help me hit my passive income goals faster.
Finding dividend shares to buy
Although I have talked about an average dividend yield of 6% in my example, I could try and hit my target faster with a higher yield – or slower with a lower yield. On its own, though, yield would not inform my investing choices. A company may pay a high dividend, but find its business starts to struggle in future. That might lead it to cut its payout.
That is why I would hunt for dividend shares I could buy in businesses with strong prospects and enduring customer demand. Finding the right shares to buy now could help my passive income streams for decades into the future.