I want to boost my income and investing in dividend shares is one option I would consider. By owning shares that pay out dividends, hopefully I could start generating what are known as passive income streams – in other words, earnings for which I do not need to work.
How would I do this if I had no previous experience buying shares? Here is is one way I would go about it as I aim for passive income streams of £3,000 per year.
The link between income and yield
If starting with a target income in mind, it is important to understand the concept of yield. Just as an interest rate indicates how much income I would expect to receive on £100 of savings, yield shows the same for dividends. So a dividend yield of 5% means that if I owned £100 of shares in a company, I would expect £5 of dividend income per year from it.
Dividends are never guaranteed though, and a company can stop them at any time. So I do not see a company’s prospective dividend yield as offering me the certainty of return I would typically get from the interest rate on a savings account.
If I did invest in shares with an average yield of 5%, to target £3,000 of annual income I would need to invest £60,000. For a higher yield I would need less – if I invested £30,000 at an average 10% yield, I could hopefully target £3,000 of annual passive income. But higher yields can often indicate a higher risk.
Focus on quality
That is why I would not just look at a list of dividend shares and focus on those with the highest yields. Instead, I would try to find shares that I felt could sustain — and hopefully increase — their dividends over time.
So, for example, Guinness owner Diageo has a portfolio of premium drinks brands that give it pricing power. That can help it offset the potential profit impact of rising production costs as inflation hits. The company is highly cash generative, something that can help it pay consistent dividends. Indeed, it is one of a small number of UK shares that have seen their dividends increase annually for more than a quarter of a century. At the moment though, Diageo’s dividend yield is a modest 2%. So, while I could earn passive income from it, to aim for earnings of £3,000 a year just from Diageo shares would require me to invest £150,000.
Passive income from a diversified portfolio
But in reality, I would not invest my whole portfolio in one company. No matter how good it is, some unforeseen problem in its business could hurt its future ability to pay a dividend. Instead, I would spread my funds over a diversified group of shares and companies.
Some may have lower yields and some higher ones, but the average yield is what determines how much I need to invest to target £3,000 each year in passive income. However much I would need, if I do not have it today I could still start drip-feeding in a smaller amount. Even if I do not hit my £3,000 target straight away, I could hopefully build up to it over time as my funds allow.
The post How I would target a £3,000 annual passive income from dividend shares appeared first on The Motley Fool UK.
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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
