The idea of receiving extra income is appealing – especially if it is not accompanied by extra work!
That is why I spend money regularly buying dividend shares. That can help me build up passive income streams that could last for decades, even if I start with no money. Here is how I could put such an approach into action by putting aside £5 each day.
Little and often
The idea of investing five pounds a day might not sound like the foundation of huge income streams. It is true that, in the early years, my extra income would be modest. But the habit of regular saving would mean that over time my income streams could grow. Here is an example.
Imagine that I invest my first year’s total savings of £1,825 in shares with an average dividend yield of 5%. That ought to earn me extra income of just over £91 that year. In the second year, doing the same, I would hopefully buy shares yielding another £91. But I should also earn the £91 of dividends from shares I had bought the previous year and still owned.
After a decade, in this way I should be earning over £900 a year of extra income from my plan of investing £5 a day. At that stage, even if I stopped putting any more money in, I would hopefully keep getting that extra income for as many years as I held the shares.
Boosting my extra income by compounding
But wait. What if instead of taking out the dividends as cash in the early years, I reinvested them? That is what is known as compounding. Doing that means the dividends themselves could earn dividends. After 10 years of compounding at 5% annually, my £5 per day should have created a portfolio worth nearly £23,000. That would hopefully earn me almost £1,150 in dividends each year. That is over £20 a week in extra income from my £5 a day.
This example presumes share prices and dividends will remain the same. In fact they could move down – or up. But the principle is clear: compounding could help me boost my future extra income streams.
Finding dividend shares to buy
To put this plan into action, I would need to buy shares that pay dividends. Such payouts are never guaranteed, even when a company had made them in the past.
So how would I decide which shares might suit my objective of extra income? I would focus on a company serving a market for which I expect to see long-term demand, with some competitive advantage. For example, I expect demand for insurance to remain high and Direct Line’s brand gives it a unique place in the market that can help it attract and retain customers.
Right now, the Direct Line yield is actually more than double the 5% I used in my example above, at 10.5%. A share like that could mean I earn more extra income than I expected above. But sometimes businesses perform worse than hoped. For example, Direct Line could find price inflation in the second hand car market eats into profits.
That is why I would spread my daily £5 across a diverse range of companies. All I need to do is find the right ones for me!