There are different ways to earn passive income. One I like is investing in the shares of blue-chip companies that pay dividends.
I like that because it is genuinely passive and means I can benefit from proven cash generators rather than needing to start up my own income-generating enterprise. On top of that, the upfront costs can be tailored to meet my own financial circumstances.
Let me illustrate by walking through the steps I would take if I wanted to target a monthly passive income stream averaging £1,000.
The role of dividend yield
In some ways the easy part of this is doing the maths. £1,000 a month adds up to £12,000 annually. How much I would need to invest to earn that would depend on my dividend yield. If I could earn a 5% yield, for example, it would take £240,000. At a 10% yield I would need £120,000.
The good news is that I can start with what I have! Rather than investing a lump sum, I could simply begin by making regular contributions that match my financial circumstances, then building up to my passive income target over time.
Avoiding yield traps
So would I just go for the highest yielding shares I could find? No!
Yield is a snapshot based on current share price and dividend. But no dividend is guaranteed to survive. A yield trap is a share that has a high yield now, but later cuts its dividend.
So I would look at the source of a company’s dividends. As an example, consider my investment in Legal & General (LSE: LGEN). The business operates in an area I expect to see strong demand over the long run, namely financial services, with a focus on retirement-linked products such as pensions.
It has some competitive advantages that can help it do well, from a strong brand to a large customer base. Legal & General generates significant cash flows thanks to that model, enabling it to support a meaty dividend yield that currently stands at 9.2%.
Building the income streams
Will that last? Legal & General has cut its dividend in the past and this year signalled plans to reduce its projected annual growth in dividend per share (though that is still growth!). If a rocky market leads policyholders to cash in, that could hurt profits and free cash flows for the firm.
Still, balancing risk and reward, I am happy owning Legal & General shares. A 9.2% yield is high but in the current market I think I could comfortably target a 7% average yield while sticking to blue-chip companies with proven cash generation potential.
Doing that, my £1,000 monthly passive income target would require an investment of around £172,000 either as a lump sum, or built up over time through regular contributions. If investing regularly, I could still earn passive income along the way, albeit at a lower level than my ultimate target.
My first move would be to set up a share-dealing account or Stocks and Shares ISA I could use to put my plan into action.
The post How much would I need to invest to earn £1,000 in passive income each month? appeared first on The Motley Fool UK.
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C Ruane has positions in Legal & General Group Plc. 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.
