Passive income has become a popular idea in recent years. The simple appeal of generating money without having to work for it attracts many people. Investing in UK dividend shares is among my favourite passive income ideas. It enables me to reap the rewards of the hard work and ingenuity of successful listed companies.
Here’s how I would use UK dividend shares to start earning passive income, even if I’d never invested before.
Learn about shares
The first thing sounds basic, but it trips a lot of people up. I would start to learn about shares. What are dividends? How are they funded? How are share prices determined? These sound like basic concepts, but it’s important to get to grips with them. That could stop me making some common beginner’s mistakes, like investing in a company that currently has an attractive dividend but whose future cash flows seem unlikely to cover it. That happened last year, for example, at Imperial Brands.
Fortunately there are lots of easy ways to learn about shares and the stock market nowadays. At this point, I’d try to focus on learning the basics of how UK dividend shares work and focus on avoiding common beginner’s mistakes, rather than starting to choose the best shares for me.
Zoom in on compelling UK dividend shares
Once I felt comfortable with how the stock market operates, only then would I start to look for specific UK dividend shares I could buy with the goal of generating passive income streams.
To lower my risk, I’d diversify across different shares and business sectors. Even the best run company can face unexpected difficulties, after all. I’d also limit my initial search to large companies with a substantial trading history. There are certainly some great dividend choices among smaller, newer companies. But they can also be more tricky to understand as a beginner. A large UK dividend share such as Unilever or Tesco can still face unexpected problems, but broadly speaking they ought to be less subject to dramatic turbulence than some very small or obscure companies on the fringes of the market.
I’d focus on shares that have strong free cash flow, as that’s ultimately what funds dividends. I’d also look for companies with what I felt was a sustainable competitive advantage, and prospects for future business growth. So, for example, both Unilever and Tesco would make the cut for my portfolio.
Start to invest then enjoy the passive income
Once I had a shortlist of UK dividend shares for my portfolio, it would be time for me to invest. If I didn’t have any money to invest, I would start to put aside a bit each day or week and hopefully, it could soon add up and I could start generating passive income streams.
After that, I would sit back and enjoy any passive income that came in. It can be tempting to dive in and out of the markets, trading often. But trading can have costs. It also involves a bit of work each time, so if one does it often, that starts to defeat the idea of truly passive income.
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Christopher Ruane owns shares in Imperial Brands. The Motley Fool UK has recommended Imperial Brands, Tesco, and Unilever. 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.
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