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Putting some savings to work can be a simple way of setting up passive income streams. For example, by investing £9k in a range of dividend shares, I think someone could realistically target £108 each month on average in passive income.
Here’s how.
Setting up a passive income machine, thanks to dividend shares
In my example, I make three key assumptions. One is a compound annual growth rate of 6%. That seems plausible to me in today’s market, even while investing in blue-chip shares.
The second assumption is that the dividends are initially reinvested (compounded) and, after a period of time, the portfolio is reinvested (if necessary) in dividend shares yielding an average 6%.
It might have been like that all along, but it could also have been that some of the growth came from share price increase. When it comes time to draw down the passive income, the whole portfolio should be yielding 6%, not just compounding in value at that level.
The third assumption is that the investor stops compounding and starts receiving the passive income after 15 years. This is a serious income building plan, not some get-rich-quick quackery.
The same approach could be applied much sooner, but the 15-year timeframe should enable a bigger passive income than, say, waiting only two or three years.
A 6% dividend yield’s possible, while laser-focused on quality
At the moment, the blue-chip FTSE 100 index of leading shares yields 3.4%. So the 6% target I use here is quite aggressive. But I think it is achievable even sticking to members of the FTSE 100.
For example, I own shares in Legal & General (LSE: LGEN). At the moment, it yields 8.6%. Even better, the financial services firm has set out plans to keep growing its dividend per share annually, as it has done over the past several years.
Now, this month it has also set out plans to sell its US protection business. While that could boost shareholder returns in the short-term, it will also likely mean lower long-term cash generation for the smaller firm. That is a risk to the long-term dividend outlook.
But I think there is a lot to like about Legal & General and have no plans to sell my shares. Its target market is large and thanks to its powerful brand and large customer base it has a strong competitive position.
As the recent news demonstrated, management is focused on shareholder returns. From a passive income perspective, I think that is good news for me and lots of other small, private shareholders who get dividends from the company without needing to work for them.
Turning savings into an income machine
Of course, while that is all well in theory, to join in dividends from Legal & General or any other company, a would-be investor needs to turn into an actual investor.
To get the ball rolling, they could put the £9k into a share-dealing account or Stocks and Shares ISA, so they are ready to invest.
