Building passive income is a great idea, in my view. It’s almost money for nothing because I don’t have to work overtime to earn it. It might sound too good to be true, but it’s certainly possible. With a catch. I do have to take some investment risks to start building passive income. My favoured strategy is by investing in dividend stocks. This is where I buy shares of a company that pays its shareholders a dividend, or a cut of the profits it generates. The risk is that I might lose more than I initially invested, because share prices can be volatile. Particularly, if the company’s profits fall.
But I still think dividend stocks are great way to generate passive income. Here’s how I’d do it starting with £10 a week.
1. Share dealing accounts and starting early
It’s important that I start saving early, and be consistent with my plan. That’s because £10 a week isn’t a great amount initially. So I would set up a direct debit and pay it into my share dealing account. This way, I wouldn’t forget.
Share dealing accounts charge fees, so I’d need to bear this in mind. Some also charge dealing fees, which is something else I’d need to consider.
The most important thing for me is to stick with my saving plan. Once I’ve built up, say £100, I’d start buying dividend stocks.
2. Diversification, and dividend stocks I’d buy
I would also need my portfolio to be diversified. This means I’m not buying only one company, or even different companies in the same sector. It would be easy for me to simply pick the highest dividend yielding stock, and just keep buying shares of the same company. But if it runs into trouble, the dividend would be cut. Even worse, the share price might crash and I’d lose some of my initial investment.
This happened recently at BP. The company paid a reliable dividend for many years, but when the oil price crashed in 2020, the dividend was cut.
Today, I’d buy shares in Aviva, Rio Tinto, and GlaxoSmithKline. Each company operates in a different sector, and the dividend yields are over 5%.
Any investment I make is always a balance of risk and reward. But as long as I fully research the companies before I invest, then I can make a decision on whether the investment is right for my portfolio.
3. Patience and passive income
Once I build up to £100 in my share dealing account, I’d start buying shares in the companies I’ve researched. It would therefore take 10 weeks for me to start building my passive income. This is why I have to be patient and allow my investment process to work over the long term.
Over the full year, I could have bought £520 worth of dividend stocks. If my average dividend yield across my portfolio is 5%, I’d earn £26 in passive income across the year. It’s not much to start with, but it really does build over time. Then, if I can increase my £10 to maybe £20 each week, my passive income could get a further boost.
Dan Appleby owns shares of Rio Tinto, GlaxoSmithKline and Aviva. The Motley Fool UK has recommended GlaxoSmithKline. 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.
This post was originally published on Motley Fool
