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One popular way to earn passive income is investing in shares that pay dividends. It is an approach that can be tailored to someone’s individual financial circumstances.
It can also be pretty lucrative, especially if that someone has patience to wait and adopt a long-term approach to investing.
As an illustration, here is how they could target a monthly average passive income of £841 from an initial investment of £20k.
How to calculate prospective passive income
Let me explain how I arrived at that number. It is based on an investor compounding £20k at 9% annually for two decades, then generating a passive income from it at a 9% yield.
That compounding could involve both capital gain and any dividends paid. Share prices can fall though, and that also would affect the overall performance, so the final figure is by no means guaranteed.
As for a 9% yield 20 years down the line, based on today’s market there are some quality shares yielding that much – but careful selection is important. Some shares have high yields because investors doubt that the dividend can be sustained.
Finding shares to buy
What sort of shares do I have in mind here? As an example, one I think investors should consider is FTSE 100 asset manager M&G (LSE: MNG).
For some years, it has had a policy of aiming to maintain or grow its dividend annually. It has recently simplified that to a policy of targeting annual increases in the dividend per share. I see that as a vote of confidence by the company’s board.
That is likely music to shareholders’ ears, especially as M&G already yields an impressive 7.8%. That is over double the FTSE 100 average.
The company has a number of strengths, including a large customer base, strong brand and long experience in asset management.
A recent tie-up with a Japanese financial services firm could help bring in more funds to manage. I see that as positive, because one of the risks that has been concerning me about M&G shares is that policyholders have been withdrawing more funds than they put in. That is a risk to profits.
Getting started
All shares have risks, of course. One simple way smart investors aim to mitigate them is to diversify across different shares. Twenty grand is ample to do that.
It is also important to choose high-quality shares trading at attractive prices. It can be hard to know whether shares really fit that bill. Like billionaire investor Warren Buffett, I therefore stick to businesses I feel confident I can understand.
It is all very well having a passive income plan – but how can someone turn it into reality? A useful first step, in my view, is to set up a way to put the £20k to work in the market. Actually, it is possible to start with less, but the passive income streams would be proportionately smaller.
To do that, an investor could compare some different options for a share-dealing account, Stocks and Shares ISA or share trading app.
