Money won’t solve our problems, but passive income will make them all a little smaller. Who wouldn’t want a little extra cash without having to work for it?
All forms of passive income take time and money, but there’s only one stream I can start today with just the leftover cash in my bank account and an hour’s work a week.
Dividend investing.
What are dividends?
Dividends are a portion of profits a company pays out to shareholders over a year. The amount paid is called a ‘yield’ and is often represented as a percentage value of the share price. So, if I own a share that’s worth £100 and the yield is 5%, I will be paid £5 per year for the share I own. It’s worth remembering that not all companies pay dividends and those that do are under no obligation to keep paying them.
Knowing my passive income goals
If I want to earn around £250 each month in dividends, then I need to know what the average UK dividend yield is and work out how much money I’ll need to invest.
Right now, that average is between 3% and 4%. There are lots of companies that pay more though, sometimes as high as 13%! However, dividends that high can be very risky. If I aim to build a portfolio with, say, an average 5% yield then I will only need £60,000 to reach my £250 a month goal.
Now, £60k is not a small amount of money, but that shouldn’t stop me from working towards it. Many share-dealing accounts let me automatically reinvest dividends. This way, I create compound interest that helps grow the portfolio. It will take time, but with patience and a little care, I can be on my way to building a passive income stream.
One hour’s work per week
It’s tempting to chase after really high-yielding stocks to boost passive income. However, as I mentioned, high-yielding stocks can come with higher risks and are often unsustainable.
Here’s where the one hour of work comes in.
Research is key. All companies publish annual reports on their financial status and are usually very easy to find online. They can often be dry reads, but the important information is all there.
I concentrate on a company’s current free cash flows. This can be found in its annual report, which is available free online. This will determine how easily it can pay a consistent dividend. Next, how probable is it that it will be able to maintain high levels of free cash flow? This comes down to opinion mostly. But, if a firm has a long-term competitive advantage, such as a well-known brand or patented technology, itcan be a positive indicator. I also consider net debt. After all, if it has to use its free cash flows to service debt, there won’t be much left to pay dividends.
Moving to the next steps
Once I find suitable companies that meet my risk tolerance, I’m ready to start. One last thing I will do, however, is spread my investments out over several industries. No one can predict the future and one company that looks good now could fail in the years ahead. But as long as I’m careful and do my research for just one hour a week, I’m on my way to my passive income goal.
James Reynolds has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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
