There are lots of different ways to try and earn passive income, some more passive and income-generating than others.
The approach I use is to buy shares in proven blue-chip companies that pay dividends. With the stock market experiencing a lot of turbulence over the past couple of weeks, buying such shares now could prove more lucrative than just a short while ago.
With a spare £9,000, someone could use this approach to target a monthly passive income of £490 on average.
Here’s how!
Share price and yield are connected
How much passive income a share earns depends on two factors – the size of the dividend per share and what someone pays for that share.
For example, if a share pays a 5p dividend annually and an investor buys it for £1, the yield is 5%. But if that price halves and the investor buys more shares, he will earn a 10% yield for those shares even though the dividend per share is the same.
So, when the stock market pushes share prices down – as happened for many shares at some point this week – it can offer the opportunity of earning a higher yield.
Look out for the risks, not just the rewards
That presumes the dividend is maintained, which is never guaranteed. A tumbling stock market can reflect City nervousness about how businesses are set to perform. If they do badly, they may cut or even cancel their dividend.
To try and manage that risk, an investor ought to diversify their portfolio. And £9,000 is ample to do that.
It is also important to focus on buying into quality companies at an attractive share price and only then consider the yield, rather than just investing in high-yield shares without properly understanding them.
One share to consider
For example, asset manager M&G offers a 10.9% yield. But that alone is not why I think investors should consider it.
While M&G aims to maintain or grow its dividend per share each year, it may not. It has been battling with investors pulling more money out of its core business than they put in. A nervous stock market could exacerbate that trend, hurting revenues and profits.
However, I think it has some helpful tools in its arsenal.
It operates in a large market with resilient customer demand and has a customer base in the millions. It has a strong brand and a business model that has proven excellent at generating surplus cash, the stuff of which dividends are made.
Taking the long-term approach
My example presumes a lower average yield than M&G’s 8.5%.
That 8.5% is still well over double the FTSE 100 average, but I think it is achievable in the current market, where some blue-chip shares have tumbled in price. Indeed, the M&G share price is almost a fifth cheaper than at its high point last month.
Reinvesting dividends (known as compounding) can boost passive income streams for the long-term investor. Compounding £9k at 8.5% annually for 25 years, for example, should produce £490 of dividends per month.
A shorter timeframe could still work, although the target income would be lower.
Either way, a useful first step would be identifying a suitable share-dealing account or Stocks and Shares ISA through which to invest the £9k.
This post was originally published on Motley Fool
