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Passive income ideas come in many shapes and sizes. One I like – and indeed use myself – is as simple as buying shares in blue-chip companies then collecting the dividends.
That can be fairly lucrative. It also means that, rather than try and start some low-effort business from scratch myself, I can benefit from the hard work and competitive advantages of already successful FTSE 100 businesses.
As an example, here is how an investor willing to adopt a long-term approach could target close to £1,000 of passive income each month by investing £20,000 in the stock market.
Getting ready to invest
A first move would be preparing the groundwork to start buying shares, even if those shares are yet to be decided upon.
There is a wide variety of different share-dealing accounts and Stocks and Shares ISAs available. Before putting £20k into one, I think it makes sense for an investor to decide what might seem best for their own financial circumstances and investment objectives.
How to build long-term dividend income streams
At face value, the goal I am discussing here may seem impractical. £980 a month is £11,760 a year. For an investment of £20k, that would represent a dividend yield of close to 59%.
Even if there was a FTSE 100 share that yielded 59% (and there are none anywhere near), that alone would be a massive red flag for me. On top of that, I would never put all my eggs in one basket so would diversify across a number of shares.
But remember that I said I was discussing a long-term approach here. Long term can be an investor’s friend. Not only does it mean that a great company bought at an attractive price can hopefully prove its worth, it also allows time for dividends to be reinvested – and, in turn, hopefully earn more dividends themselves.
That simple but powerful approach, known as compounding, can be a major force magnifier for the savvy investor.
If an investor put £20k into a portfolio of shares yielding an average 9%, then after 22 years of compounding that portfolio ought to be throwing off passive income of more than £980 a month, on average.
Finding shares to buy
In fairness, 9% is hardly an average yield for a FTSE 100 share. That currently sits at 3.6%.
But that does not mean 9% is unachievable. As an example, consider one share in my portfolio: Legal & General (LSE:LGEN). The FTSE 100 financial services provider currently offers a dividend yield of 9.3%. Management has also set out plans to grow the dividend per share annually.
It has done that since a cut in the wake of the financial crisis, bar one year during the pandemic when the payout per share was held flat.
Thanks to a large target market, strong brand, sizeable customer base and proven capability to generate excess cash flows that can fund a dividend, I feel confident that Legal & General could keep growing its payout in years to come.
Will it happen? The business has reported weaker profits in the past couple of years and one risk I see is stock market turbulence leading policyholders to pull out funds, hurting profits.
However, I plan to hold the share and hopefully keep earning passive income from it.
