If I could generate a decent amount of passive income each month, that could relieve some of the financial pressure of my daily life. Even if it was not enough to substitute for a working salary, at least it could come in handy for paying bills, funding some luxuries and having some extra cash on hand.
One of my favourite passive income ideas is investing in shares that pay me dividends. Here is how I would build a dividend share portfolio with the target of earning £500 each month in passive income.
Dividend shares as passive income ideas
Shares can sometimes seem a bit complicated to people who have never owned them. But basically, a share is what the name suggests: a tiny sliver of a company. So, for example, imagine I buy shares in BP or HSBC. If they make a profit and divide it between shareholders, I will typically be entitled to some of it.
So, I could get some of the benefit of the hard work of BP or HSBC. But instead of going to work at the company each day and earning a wage, I simply use my money to buy some shares in it. The income I get is in the form of dividends. These are never guaranteed, so I would buy dividend shares in different companies operating across a variety of industries. That way, if one does not do as well as I expect, it would only be a small part of my overall portfolio.
Targeting a specific passive income
My target of £500 each month adds up to £6,000 per year in passive income. If I could buy shares paying 10% of their cost in dividends – what we call the ‘yield’ – that would mean I’d need to invest £60,000.
In practice, 10% yields are unusual. Such a high yield can suggest a heightened risk at a company, for example because its profits are seen as difficult to sustain in future. But a 5% yield is available from quite a few FTSE 100 shares. That would require me to put in £120,000 to aim for £500 a month in passive income.
I could do this in a couple of ways. One option would be to put a lump sum of capital into my portfolio today and then hope to start earning £500 in monthly passive income from it. A second approach would allow me to build up to my target more slowly by putting aside some spare money each week. That would take me longer to hit my £500 monthly target. But it would mean I could start building towards a passive income goal even if I did not have a lump sum of capital in the beginning.
Finding dividend shares to buy
Whatever approach I decided to take, to put my plan into action I would need to start buying dividend shares. The right dividend shares for me would depend on my investment objective and risk tolerance.
Above all, I would focus on quality. So for example, if I found a 5% yielding share but did not think the company’s business could support the dividend in future, I would not buy it. Instead, I would look for companies with sustainable sources of competitive advantage that I felt could lead to ongoing free cash flows. That, after all, is what a company needs to fund dividends.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended HSBC Holdings. 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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