Although a lot of people like the idea of effortless earnings, I think it does take a bit of work to turn the idea into reality. One of my favourite passive income streams is dividends from shares. I like that because I do not need to do anything once I have bought the shares, and it does not need a lot of money to begin earning.
If I wanted to set up such passive income streams from scratch, here is how I would go about it with £35 a week.
Step one: get into a habit
My first move would be to start putting aside £35 a week – right now. That could be in the form of saving cash, or setting up a regular electronic transfer. Either way, I think it would be important to get into a regular habit of putting aside the money each week. With that sort of discipline, I feel I would be less likely to wobble when other spending priorities popped up.
Why does that matter? Basically, my plan is to invest in dividend shares and the more money I invest, the higher my likely return will be.
Step two: identify the right shares for me
There are a lot of shares out there, but only some pay dividends. Even those that do are not guaranteed to keep paying them in future. To reduce the risk from any one share, I would be looking to build a portfolio of dividend shares diversified across different companies and business areas.
How would I pick these shares? I would hunt for companies with business models I thought could generate substantial free cash flows in future. That matters because cash flow is ultimately what allows a company to keep paying dividends. To identify companies that could hopefully keep generating free cash flows in future, I would look for a sustainable competitive advantage. For example, Tesco is the UK’s leading retailer. Its large estate of shops is something it would be hard for a competitor to recreate. Online shopping could dent sales – but Tesco has been aggressively growing its own online sales. So that makes me think it could continue to generate sizeable profits for years to come. That could help the retailer fund its dividend.
I think it is important to focus on my own situation. The shares that are right for other investors might not suit my own investment objectives or risk tolerance. So, for example, I hold the digital ad agency S4 Capital in my portfolio. But if my objective was purely passive income, a growth share like that, which does not pay dividends, may not be suitable. Instead, I would focus on shares paying dividends – and that I reckoned could keep doing so.
Step three: start generating passive income
Identifying the right shares for me is not enough to start generating passive income. That will only happen when I actually start buying them.
With £35 a week, it will probably take me some months before I have enough funds to buy a diversified portfolio of shares. I would use that time to save. I would also set up a share-dealing account or a Stocks and Shares ISA. While waiting, I could begin the hunt for dividend shares that might be ideal for my passive income plan.
Christopher Ruane owns shares in S4 Capital. The Motley Fool UK has recommended 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.
This post was originally published on Motley Fool
