Passive income is sometimes associated with weird business ideas and improbable schemes. My own approach is more mundane — but it works.
I invest money in blue-chip companies with proven business models I hope can pay me passive income in the form of dividends.
Taking a long-term approach, that can be very lucrative. If I had a spare £20,000 today, here is how I would use it to try and earn almost £1k each month, on average, in dividends.
Getting ready to buy shares
My first move would be setting up an account I could put the £20k in time to start buying shares.
There are lots of choices available, so I would take time to decide what share-dealing account or Stocks and Shares ISA seemed the best match for my own needs.
I still would not invest just yet though. I would first take time to learn a bit more about how the stock market works.
Building a dividend share portfolio
The next step on my passive income journey would be to start buying shares. No matter how carefully I choose, the unexpected can happen. So I would split the £20k evenly over five to 10 different shares, something known as diversification.
I would not focus on finding shares with the highest dividend. After all, dividends are never guaranteed.
For example, my Vodafone shares have a dividend yield of 10.7%, ordinarily meaning I should hopefully earn £10.70 in dividends for each £100 I invested at today’s share price. But the telecoms giant has announced plans to halve its dividend.
When hunting for possible passive income streams in the stock market, I look for great companies selling at an attractive price that I think ought to generate sizeable free cash flows they can use to fund dividends.
One share I’m eyeing
As an example, consider Legal & General (LSE: LGEN), a share I would happily add to my portfolio if I had spare cash available.
The FTSE 100 financial services giant operates in an area that I expect to see both significant and robust long-term demand. Its large customer base, strong brand and expertise in fund management all help contribute to its business success and I think could well keep doing so.
The business is solidly profitable and generates sizeable cash flows. Its dividend yield is 8.1%.
Not everyone in the City seems convinced. While the yield is attractive, the share price has fallen 7% in the past five years. One risk I see the firm facing is any sudden market downturn leading clients to pulling out funds and hurting its profits.
Having a target
On balance though, Legal & General is the sort of dividend share I would happily own.
Still, even if my diversified portfolio yielded 8% (over double the FTSE 100 average), my annual passive income would be £1,600. That is far off my target.
But if I reinvested my dividends, I could hopefully hit my target. That is known as compounding. Compounding at 8% annually, after 26 years I ought to be earning over £980 monthly in passive income!
If I did not want to wait that long, I could start earning passive income much sooner but at a lower level.
The post £20,000 in savings? Here’s how I’d use it to target £980 of passive income each month appeared first on The Motley Fool UK.
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C Ruane has positions in Vodafone Group Public. The Motley Fool UK has recommended Vodafone Group Public. 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.
