The idea of earning passive income by buying dividend shares appeals to me for several reasons. First, it is genuinely passive – I can buy the shares and then benefit from any dividends they pay. Secondly, I see many large income payers like BP and Vodafone as leading firms in their fields.
Based on that, I think investing regularly in such shares could help boost my passive income streams. Here is how I would ultimately target £500 a month by investing £190 on a monthly basis.
Saving to invest
Putting aside money on a regular basis to invest in dividend shares could help me form a habit. That may be good as it could encourage me to keep saving each month even when other spending priorities reared their heads.
I would set up a share-dealing account or Stocks and Shares ISA in which to invest. But I need to be realistic about the relationship between how much I invest and the amount of monthly passive income I could earn. £190 a month would add up to £2,280 in the first year. If I invest that in shares with an average dividend yield of 6%, I would expect to receive monthly dividend income of around £11. That would be welcome – but is a far cry from £500.
To hit the higher number while investing £190 each month in dividend shares, I would need to be patient and invest over the course of many years. Even then, though, it could be a long wait. If the 6% average divined yield of my portfolio remained constant, I would need to wait more than four decades to hit my target.
The good news is that as I grew the amount of money I invested, then hopefully the monthly passive income would increase too even if it took a long time to hit £500. Still, could I try and reach my target faster?
Compound returns
I think I could, thanks to what is known as compounding. Basically, instead of taking out the dividends in cash, I would invest them straight back into more of the same shares. Like a snowball running downhill, in time the reinvested dividends would themselves effectively be earning dividends.
Thanks to that, in just 22 years, I would hopefully have a portfolio of shares worth over £100,000. With an average dividend yield of 6%, I should thus earn passive income of £500 each month.
In this example, I have presumed share prices and dividends remain the same over time. In practice, that might not happen. But the principle remains clear: compounding could help me hit my passive income goals faster.
Finding dividend shares to buy
Although I have talked about an average dividend yield of 6% in my example, I could try and hit my target faster with a higher yield – or slower with a lower yield. On its own, though, yield would not inform my investing choices. A company may pay a high dividend, but find its business starts to struggle in future. That might lead it to cut its payout.
That is why I would hunt for dividend shares I could buy in businesses with strong prospects and enduring customer demand. Finding the right shares to buy now could help my passive income streams for decades into the future.
This post was originally published on Motley Fool
