Some of the simplest passive income ideas can turn out to be highly rewarding ones. Take investing in dividend shares as an idea. I like this because it really is passive: I just need to buy the shares and wait, hoping for the income to start adding up.
If I had £1,500 today and wanted to start generating passive income, here is how I would do it.
Getting ready to invest
At a practical level, before I can buy any shares I will need some way to purchase them. That could be a share-dealing account or Stocks and Shares ISA, for example. I would take some time to figure out what best suits my needs. For example, as my objective here is passive income, will I be able to withdraw such income regularly or would that incur additional fees?
I would set the account up immediately. That way, when I identified some dividend shares I wanted to buy, I would be ready to act at once.
Spreading the money
I would plan to spread the money evenly, putting £500 into each of three companies. I would also make sure they operated in different business areas.
The reason for this is what is known as diversification. In layman’s terms, it is the principle of not putting all of my eggs in one basket. No matter how attractive a company may seem today, a business can run into unexpected problems that stop it paying a dividend. If I diversify across three companies, the impact on my passive income streams of one company running into difficulties will be reduced.
Starting to choose the shares
One common field for passive income investors is tobacco. Companies here tend to generate high free cash flows, which can fund beefy dividends. British American Tobacco yields 6.4%. That means that if I spend £100 on its shares today, I would hopefully earn £6.40 in dividends in a year. So a £500 investment could earn me £32 in a year.
Like any dividend, though, British American’s is not guaranteed. A decline in cigarette usage in many countries could hurt revenues and profits. The company is addressing this risk, though. Last year, cigarette revenue actually increased, partly due to price rises. The company is also spending heavily on new tobacco alternative products like the ‘modern oral’ category.
More passive income ideas
I would also invest in asset manager M&G. It has a well-recognised brand that can help it attract and retain clients. Having said that, it could still face difficulties retaining clients if its investment managers do not perform well.
Yet with the large amounts of client money at stake, even a small commission can be lucrative for a firm like M&G. It currently yields 8.6%, so my £500 would hopefully earn me £43 of passive income in a year.
My third choice would be National Grid. Power generation can seem like a boring and slow-moving business, but from a passive income perspective that makes it attractive to me. Shifting patterns of energy consumption could require more capital expenditure, which might eat into profits. But National Grid has a proven business model and its existing infrastructure is a strong competitive advantage. It yields 4.6% so a £500 investment would hopefully earn me £23 in a year.
With my £1,500 invested like that, I would be hoping for annual passive income of £98 – for no work!
Christopher Ruane owns shares in British American Tobacco. The Motley Fool UK has recommended British American Tobacco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
This post was originally published on Motley Fool
