Passive income is exactly what it sounds. Money earned without having to work for it. That may appear too good to be true, but actually lots of people already earn passive income on a regular basis – and in some cases, a lot of it!
One approach I use to try and generate such income is to invest in companies I hope will pay me dividends. Here is how I could try to generate a four-figure passive cashflow each year by investing £250 a month into income shares.
Regular saving and investment
In this example I use £250. But I could equally use £25, or £2,500 a month. The speed at which I might hope to hit my goal would differ, based on how much I saved each month. But the basic principles underpinning the approach would be the same.
Whatever the amount, what I see as crucial is I choose an amount that is realistic, given my own financial circumstances, and really focus on putting that amount aside each month. That could help me build the discipline of saving regularly.
I would save the money in a share-dealing account, or Stocks and Shares ISA. That way, once I have saved enough money and decided what income shares I want to buy, I would be ready to invest immediately.
Finding income shares to buy
So what sort of shares would I be looking for? To reduce my risk, I would diversify across a range income shares. That way, even if some of my choices turn out to be disappointing, the impact on my overall passive income streams would hopefully be limited.
Dividends are the way a company pays out cash it generates from its business and does not need to spend on things like building new factories or product development. So when hunting for income shares for my portfolio, I would look for businesses in a market I expect to see sustained customer demand. If they have a competitive advantage that could give them pricing power, it could help generate good operating profits.
However, operating profits can be eaten up by debt repayment, so I would also look at the company’s balance sheet. If I decided the shares looked attractively valued and I liked the dividend yield, I would consider buying them for my portfolio.
An example I hold in my portfolio is US tobacco company Altria. Its well-known brands like Marlboro give it pricing power and the 8.5% dividend yield is attractive to me. One risk is declining numbers of smokers leading to smaller profits for the cigarette maker. However, it is working to develop non-cigarette products that might help mitigate that risk.
Going for my target
If my portfolio had an average yield of 8.5% like Altria and I reinvested the dividends, after just four years I ought to be generating a four-figure annual passive income of slightly over £1,200.
That example presumes constant share prices and dividends, which in reality are unlikely. But it demonstrates how regular saving and compounding dividends can help me use income shares to build sizeable dividend streams in just a few years.
The plan does not have to be complicated — and is genuinely passive!