There are many different ways people try to earn passive income. But by putting a little bit of money regularly into dividend shares, I think I could start seeing some returns fairly soon. Here is the passive income plan I would use with just £2 a day.
Starting small
One of the reasons I like dividend shares as passive income ideas is that I do not require much money to start. If I wanted to pursue another passive income route, such as owning a rental property, I would need a lot of cash upfront. But if I focus on dividend shares, I can start with nothing and build up my funds as I go, according to what I can spare.
It is important to go in with realistic expectations, though. Imagine that I save £2 a day. That adds up to £730 in a year. If I invest that in shares and the dividends I earn from them are 5% of what I pay for them (this is known as yield). I would expect my annual dividend income to be about £36. That is hardly going to let me retire tomorrow! But what it does do is turn a couple of pounds a day I could otherwise squander into a productive asset that hopefully can generate income for me long into the future.
Spreading the risk
Dividends are never guaranteed. If I hold a share for years or decades, it could well cut its dividend. So, if I want to set up passive income streams for life, I would diversify across different companies and business areas.
That gives me the benefit of reducing my risk if any one share turns out worse than I hoped.
Choosing dividend shares to buy
What sort of shares could help me earn passive income, both now and in the future?
A dividend basically needs to be funded by the profits a company makes from its business. So I would look for a company I think can generate strong excess cash flows for years to come. For example, miners like Rio Tinto and BHP currently generate very strong cash flows. But the next time the metal market goes into a downward cycle, I would not be surprised to see their profits fall. That could lead to a dividend cut.
By contrast, I reckon companies like National Grid and Tesco will continue to see fairly resilient customer demand and pricing in future. That could help support profits. Nothing is ever guaranteed, though, which is partly why I would buy a range of different shares.
Dividend yield is an easy way of knowing how much passive income I might expect from a share. But simply choosing shares that currently offer the highest yield can be a costly mistake. That is why I focus on a company’s future business prospects and its ability to generate ongoing large profits.
Putting my passive income plan into action
I do not think this passive income plan is particularly complicated or time consuming. But if it only remains a plan, it will not earn me a penny.
To set up passive income streams, I need to take some action. At £2 a day, I think it should be easy for me to start.
The post My £2 a day passive income plan for life 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 Tesco. 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.
