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Building a passive income stream sounds wonderfully simple — money flowing in without lifting a finger. But in reality, it usually takes years of effort and careful planning. Buying rental property or running an online side hustle, for instance, requires serious time and commitment.
That is why I think the stock market offers a more straightforward path. It is slower, yes, but dividend-paying shares in particular can provide a steady flow of income with far less day-to-day involvement.
So here is one approach to targeting £500 a month in passive income.
Why dividend shares matter
Dividend shares are the backbone of many income-focused portfolios. When a company distributes part of its profits to shareholders, that payment is called a dividend. The amount received depends on two things: the yield and the payout ratio.
The yield shows how much income an investor earns relative to the share price, while the payout ratio indicates how much of the company’s profits are being returned to shareholders. Ideally, a sustainable business will offer a decent yield while still reinvesting in growth.
Take some familiar names from the FTSE 100 index. Banks such as HSBC Holdings (LSE: HSBA), oil majors including BP, and insurers such as Aviva regularly pay dividends. Yields here often range between 5% and 7%, which is well above the market average.
HSBC as an example
HSBC is the largest bank in the UK and has been paying dividends for over 20 years. Right now, its payout ratio sits at 65.4%, suggesting a healthy balance between rewarding shareholders and retaining profits.
The business looks reasonably priced too, with a price-to-earnings (P/E) ratio of 12.2 and an operating margin of 17%. In addition, management has been buying back shares, with 2.1m repurchased recently — a move that can boost earnings per share and future dividends.
That said, there are risks. The share price has climbed only 21% this year, lagging rivals. That suggests if the banking industry declines, HSBC could be one of the hardest hit. It also has a heavy reliance on Asian markets, which makes it vulnerable to any downturn in the region. It recently announced plans to divide operations between East and West, which could be costly and add further disruption in the short term.
Even so, I think HSBC still looks like a solid option to consider for those building a passive income portfolio.
What £100 a month can grow into
To put the numbers into perspective, imagine an investor steadily builds a portfolio averaging a 6% yield, starting from zero. Over 22 years, an investment of around £100 each month could grow into £70,000 (with dividends reinvested). That pot alone would pay out roughly £6,000 annually in dividends – around £500 every single month.
Of course, that is in an ideal situation – and a lot can happen in 20 years. Dividends are never guaranteed, which is why it’s crucial to check the long-term track record of any company before investing.
History shows that patient investors who reinvest and steadily build their holdings can create reliable income streams over time. For me, the prospect of a £500 monthly passive income in just over two decades’ time is well worth the commitment.
