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Earning passive income really can be simple and largely effortless.
Take dividend shares, for example. By investing in large, well-known, and profitable companies, many people earn income in the form of dividends. A dividend is a payment some companies choose to make to shareholders when they have cash to spare.
Such an approach does not even require much money to start. From nothing today, someone who put £5 a day into dividend shares could be drawing a little over £2,000 per year in passive income a decade from now.
Here’s how!
How dividends can help grow income
Say someone invests the fiver a day into a diversified portfolio of shares that offer an average dividend yield of 7.5% (in other words, for every £100 invested they are set to earn £7.50 per year in dividends).
After doing that for a decade and compounding (reinvesting) the dividends, the portfolio will be of such a size that a 7.5% yield would equate to over £2,000 in dividends each year. Passive income galore!
Putting the horse before the cart
Now, a 7.5% is over double the current average yield of the FTSE 100 index of leading shares.
I do think it is achievable in today’s market. But it is important not to put the cart before the horse by focusing on dividend yield in isolation. After all, no dividend is ever guaranteed to last.
Instead, it makes sense to hunt for great businesses with attractive share prices and only then consider their dividend yield and passive income potential.
Even before doing that, though, a practical first step would be to choose a suitable share-dealing account, dealing app, or Stocks and Shares ISA to use for this passive income plan.
Hunting for promising income shares
Diversification is an important risk management strategy, so finding one great share is not enough.
Still, one dividend share I think investors should consider at the moment is FTSE 100 financial services company Legal & General (LSE: LGEN).
The business has focused more in recent years on retirement-linked products and services. That strikes me as a smart move, as it is a large, enduring, long-term market. Plus, Legal & General has some deep strengths that can help it compete in this field, from a well-known brand to a sizeable customer base.
It is not the only company that wants a bite of the pie, though. The competitive landscape is a perennial threat to profitability.
While Legal & General’s planned sale of a large US business will throw off lots of cash in the short term, it does also raise a longer term risk that the firm will not be able to maintain its current profit levels.
It has reduced the size of annual dividend per share increases it targets, to 2%. Still, growth is growth (if it is delivered) – and Legal & General already has a juicy dividend yield of 8.9%. That is well in excess of the 7.5% target I mentioned in the passive income plan above.
