Passive income is money accumulated without working for it. If that sounds like a fantasy, consider how many people currently generate such income, for example by owning rental properties.
Another approach is buying shares of blue-chip companies that look set to share some or all of their earnings with shareholders in the form of dividends.
If I wanted to target passive income averaging £70 each week (£3,640 a year) investing in such dividend shares, here is how I would go about it.
1. Set up a share-dealing account
My first move would be creating a share-dealing account or Stocks and Shares ISA.
2. Find money to invest
Next, I would put money into that account. It could be a lump sum, if I had enough cash on hand. How much I need is based on the average dividend yield I earn on my investments. At 5%, for example, my target would require an investment of £72,800.
An alternative would be starting with what I had (even if it was nothing) and making regular contributions. Doing that, it would take me time to build up to my passive income target.
3. Learn about the stock market
My next move would be to find out more about how the stock market works. For example, sometimes a share has a high dividend yield but its cash flows are declining. That risks a future dividend cut.
So learning about valuation and company accounts would hopefully help me as I aimed to set up resilient and hopefully growing passive income streams.
4. Set the strategy
No dividend is ever guaranteed to last though. So I would diversify across a range of different companies.
That is just one of the risk management strategies I use, alongside moves like sticking to business fields I understand and always focusing on a company’s commercial strength, not its dividend yield in isolation.
Hopefully, setting the right strategy could help me hit my goal.
As an example, consider an income share I have bought this year: Legal & General (LSE: LGEN).
I like its strong brand, existing customer base and focus on the retirement market, as I expect that to experience high long-term demand. But the share price has moved around a fair bit (it is down 9% this year).
For a while, Legal & General was on my watchlist of shares I would buy, if they became available at the right price and I had spare cash to invest. Then I bought it.
6. Start buying shares
Like any share, the FTSE 100 financial services company faces risks. For example, a sudden market fall could see policyholders cash out, hurting profits. As we saw a couple of years ago, the pensions market can also suffer from sudden external shocks, such as shifts in government policy.
At the right price though, I think those risks are worth me taking when it comes to Legal & General.
7. Start earning passive income!
With its high yield of 9.1%, the share is a lucrative dividend payer for me to own. Even at the lower 5% average I mentioned above, if I invest £85 a week and reinvest the dividends to begin with, I ought to hit my passive income target after 13 years.
This post was originally published on Motley Fool
