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Buying shares to earn passive income has worked for millions of people over centuries.
It does not always work: dividends are never guaranteed, so it is important to choose carefully.
But by taking time and research to try and buy into great companies when their shares offer both a good share price and strong income prospects, I think I could aim to build up substantial long-term passive income streams even from relatively modest contributions.
If I had a spare £200 per month to put into this plan, here is how I would target annual passive income of £7,100 over the long term.
Buying shares that generate unearned income
Critical to this plan is finding the right sort of shares. I want to buy into companies that I think could generate sizeable excess income they can use to fund dividends in future.
Although my focus is on income, I also want to make sure I do not pay too much for the shares, as otherwise I risk ending up selling the shares at some future point for less than I paid for them, even if I have received dividends along the way.
Even the best seeming share can disappoint. So I would diversify my portfolio across different companies.
One share to consider buying now
As an example of the sort of share I think investors (including new ones) should consider buying to try and set up long-term passive income stream, consider one I own: Diageo (LSE: DGE).
The firm owns a host of premium drinks brands, from Johnnie Walker to Smirnoff. The market for alcoholic drinks is a large one and I expect it to remain that way. Owning premium brands gives Diageo pricing power. That helps it generate sizeable free cash flows. That has allowed it to raise the dividend annually for over three decades.
Will that continue? Younger consumers are drinking less alcohol now than earlier generations did and Diageo has been grappling with how to tackle declining demand in Latin America specifically.
But looking at the whole picture, I am upbeat about the long-term dividend prospects of owning the share.
Dividends can add up!
At the moment, Diageo’s dividend yield is 3.1%. So for every £100 I invest today, hopefully I would earn around £3.10 in dividends annually if the payout per share stays where it is now.
In the current market I could target a higher average yield – say 7% — while sticking to blue-chip shares in proven businesses.
If I invested £200 a month and reinvested the dividends along the way (a very powerful move known as compounding), at an average yield of 7%, I would be earning over £7,100 in dividends after 20 years.
I’d make the first move now!
That plan strikes me as realistic, affordable, and potentially very lucrative.
Whether with £200 a month, higher or lower, my first move would be an immediate one, now. I would set up a share-dealing account or Stocks and Shares ISA and set up my regular monthly contributions.
