Investing in blue-chip shares that pay their owners regular dividends is exactly my definition of passive income. I earn money and do not need to work for it.
Using this approach need not be expensive. If I had a spare £200 to tuck away each month, here is how I would put it to work in the stock market on my behalf!
Getting into the savings habit
First I would set up a share-dealing account or Stocks and Shares ISA and start putting the money in each month. I believe saving a set amount on a regular basis can be a positive financial habit to get into.
The money would soon start adding up to the point that I could start buying shares. Before doing that though, I would take some time to learn about important concepts such as valuation and how dividends are funded.
Dividends are never guaranteed to last, so I would want to buy into reasonably priced firms I felt confident could maintain their payouts.
An example of one share I’d buy
As an example, consider one share I would buy more of for passive income if I had spare money to invest. It is Legal & General (LSE: LGEN), which I already hold in my portfolio.
The FTSE 100 financial services provider is focused on the retirement-linked market. That is large and likely to remain that way for decades. It has a number of strengths that help it compete, from an iconic brand to a large customer base.
That has helped it be consistently profitable in recent years. It has also raised its dividend annually for most of the past 15 years and set out plans to keep doing so, albeit at a lower rate than before.
Currently the dividend yield is 9.5%, meaning that if the dividend is maintained at its current level then investing £1,000 today ought to earn me £95 annually in passive income.
Remembering the risks
Still, the reduced rate of increase points to risks. For example, if an economic downturn leads policyholders to withdraw funds, Legal & General could see profits fall.
That is the sort of risks (and every share has some) that explain why I always keep my portfolio diversified across different shares.
That 9.5% is an unusually high yield and well above the average for Legal & General’s FTSE 100 peers. But if I chose the right shares I think I could achieve an average of, say, 6% while sticking to proven blue-chip firms.
If I did that, my first year’s investment of £2,400 ought to earn me annual passive income of £144. But I could build that by keeping up my £200 monthly investment habit and also reinvesting my dividends. That simple but financially powerful move is known as compounding.
By putting aside £200 a month and compounding at 6% annually, after a decade I would have a portfolio worth over £32,000. At an average yield of 6% that should earn me passive income of £1,950 per year, or around £163 per month.
This post was originally published on Motley Fool
