The concept of earning money without needing to work for it may sound too good to be true. But in fact, a lot of people already generate such passive income.
Some rely on schemes that require a lot of money upfront, for example buying a rental property. I like generating passive income by investing in shares that pay dividends. This idea can be put into action without having a lot of cash to hand.
If I wanted to start doing that today to target £500 in monthly passive income, here is how I would go about it.
Step 1 – start saving money
Although I could put this passive income plan into action without lots of money, if I want to buy shares then I will need at least some funds.
So I would start putting aside a set amount of money on a regular basis, such as weekly. By getting into this habit, hopefully it would stick.
Step 2 – get ready to buy shares
Having a pile of pound coins in a jar might help me earn dividends at some point — but not while they sit in the jar. So as well as saving money on a regular basis, I would put it in a share-dealing account or Stocks and Shares ISA.
That way, when I identified shares I wanted to buy, I should be ready to do so.
Step 3 – learn about shares
My plan relies on me investing money in shares that pay me dividends. Those will make up my passive income.
But what sort of shares should I buy? For example, housebuilder Persimmon has a dividend yield of 19.6% right now. That means if I invest £100 in it today, hopefully next year I will earn almost £20 of passive income from Persimmon dividends. But that yield is much higher than most shares. Is that because investors think the dividend might be cut? Could this be what is known as a yield trap?
Learning how to look at shares I might buy for my passive income plan involves me understanding the answers to questions like this.
Step 4 – hunt for shares to buy
Even once I learn more about how the stock market works in general, I will still need to decide what specific shares to buy.
To reduce my risk in case a share turns out to do less well than I hope, I would spread my money across a range of different companies. Dividends are never guaranteed.
Instead of focusing on maximising my income, I would hunt for businesses I could understand and that I think have a long-term competitive advantage. That could help them make long-term profits, which fund dividends.
Paying too much, even for a good share, can mean an unrewarding investment. So I would try to buy great companies, but only at attractive prices.
Step 5 – generate passive income!
Once I buy shares, hopefully passive income will start flowing in the form of dividends.
A target of £500 per month is £6,000 per year. If I invest in shares with an average yield of 5%, that would require £120,000 of funds.
It could take me many years to save that up. But I could start today on a more modest scale that suits whatever funds I have available.
This post was originally published on Motley Fool
