Here’s how I’d use £400 a month to create passive income investments

A common complaint I hear about the idea of using dividend shares to generate passive income is that it needs a lot of money to start with. But I do not think this is really the case. I reckon it is possible to build up an investment pot over time and use it to start generating passive income along the way.

Here is how I would set out to do that, using £400 a month.

Why dividend shares?

First let me explain why I think dividend shares make attractive passive income ideas. They really are passive. So I can buy the shares, then simply sit back and wait for any dividends that the company decides to pay to me. I do not need to do any work myself.

On top of that, I am benefiting from being able to choose between thousands of companies, including some of the most successful businesses in the world. I can look at a company like Apple or Tesco and decide that I want to share in their success (and income) by buying their shares for my portfolio. Even though I do not have to do anything myself, I can benefit from the hard work and vision of people who work diligently and successfully.

Getting into the habit

To start, I would set up some sort of share-dealing account or Stocks and Shares ISA. Once I had enough funds, I could use this to start buying dividend shares. I would set it up first, so that it was ready to use as soon as I wanted to start buying.

Then I would make arrangements to transfer £400 into the account regularly. I think discipline is an important part of passive income generation. Getting into a regular habit, I would hopefully notice the impact of the monthly payment less. I would also be more likely to focus on keeping it going, even if other demands on my finances came along.

Shares as passive income ideas

Now I would be ready to start hunting for dividend shares to buy. I would want to reduce my risk by diversifying across a number of different companies and industries. So I might not buy any shares for a couple of months at least, at which point I would have saved £800 – enough to diversify.

But I could use this time to focus on defining my investment objectives and deciding what shares might best suit my risk profile. Shares with high dividends often carry high risk. Miner Ferrexpo, for example, relies on a single mining area in the Ukraine, while tobacco maker Imperial Brands is heavily exposed to cigarette sales that are declining in most markets.

So, instead of just looking at the dividend a company pays, I really need to start understanding its business. Does it have a durable source of competitive advantage it can convert into cash flow? Can it pay that out as dividends, or does it need to use it for other purposes such as paying off debt? Once I find the right dividend shares for me, I could start building my passive income streams.

Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended Apple, Imperial Brands, and Tesco. 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.