One common way to earn passive income is to buy blue-chip shares and earn dividends, just by owning them. Over time, that can build to a substantial sum of money coming in the door without needing to work for it.
If an investor had a spare £20k, here is how they could target £5k in annual passive income from dividends.
Doing the maths on dividend income
£5k a year from £20k equates to a 25% annual return. No FTSE 100 share offers anything like that – and even if one did, I would be very wary as such a high yield can often be an indication that the City does not expect the dividend to last. After all, no dividend is ever guaranteed.
That is where compounding can help an investor. That basically means reinvesting dividends.
Imagine, for example, that an investor compounded £20k at an average annual rate of 8%. After 15 years, the portfolio would have more than tripled in value. It would be big enough that, at an 8% yield, it would generate over £5k of passive income each year.
Finding shares to buy
While 8% is well above the FTSE 100 average yield (over double it, in fact), I do think there are some blue-chip shares investors should consider when putting together an income portfolio that offer around that yield.
Case in point: Legal & General (LSE: LGEN). Known for its well-known multi-coloured umbrella logo, the financial services firm benefits from wide brand awareness, a large client base and a proven business model.
I think the retirement-linked financial services business is a promising one to be in as it involves large sums of money and looks set to hang around indefinitely.
The company aims to raise its dividend annually. The share already yields 9.3%, so that could be good news from an income perspective.
As I said above, high yields can suggest risk — and 9.3% is among the top tier of FTSE 100 yields. One risk I see is that a financial crisis could force the company to focus on meeting its capital requirements just as asset prices fall and clients pull out funds. Last time around, in 2008, we saw a cut in the dividend.
It now far exceeds what it was before that episode however. As a long-term investor, I remain upbeat about the passive income prospects offered by Legal & General shares and see them as worth considering.
Getting started
Before buying any shares, an investor needs a practical way to do so. So it makes sense to look at a variety options for a share-dealing account or Stocks and Shares ISA. Each investor has their own set of circumstances and objectives.
One thing I look out for in such a situation is fees and costs. I do not want to earn passive income on one hand only to have it eaten up on the other by paying high costs!
This post was originally published on Motley Fool
