A lot of people like the idea of getting money without having to work for it. But free money does not just fall out of the sky. Even if it does not take work in the normal sense, it will still need some activity. For example, one of my favourite passive income ideas is investing in dividend shares. But to do that, I need money and some effort. If I do not have money to invest right now, then I will need time as well.
Starting from zero today, here is how I would aim to start generating such passive income streams in the coming year.
Month one: laying the groundwork
Imagine that I have no money and zero knowledge about the stock market. Where could I start?
Well, a helpful first step would be to get into the regular habit of saving £3 a day. Why £3? After all, that is not a huge amount of money. But actually, that is the point! If I set myself a big target, I may manage to hit it at first – but could struggle when other spending needs pop up. I think £3 a day is small enough for me to make it happen each day, but big enough that it can lay the foundation for a concrete passive income plan.
Month two: learning about the stock market
The idea of investing in dividend shares may sound straightforward. But if I know nothing about the stock market, I might not even know what a dividend share is.
In the second month of my year-long plan, I would still be saving money. But I would not yet have got enough to start investing without the impact of fees eating heavily into my returns. So, for now I would keep up with my regular saving. But I would make good use of this time to learn more about how the stock market works. Specifically, I would be trying to answer the question: what sort of shares could help me set up passive income streams for years to come?
To answer that, I would need to understand how companies fund dividends and what factors typically lead to them being increased or decreased. But it would also be helpful for me to learn about share valuation more generally. Some companies pay dividends even when their business is struggling. That might seem like good news, but the benefit of me receiving a dividend from a share is reduced if the share price falls.
For example, five years ago I could have invested in Centrica for its dividends. But it has since stopped paying dividends and the share price has fallen 61% over five years. Learning about how to value companies and the likelihood of them paying dividends could make a big difference to the long-term prospects of my passive income plan. Fortunately, there are lots of helpful resources to help me begin for free.
Month three: getting ready to buy
As I keep saving money at the rate of £3 a day, I will get closer to the point when I am ready to buy dividend shares.
To do that, I will need some sort of share-dealing account or perhaps a Stocks and Shares ISA. Millions of people like me buy and sell shares, so I do not think it needs to be a complicated thing to set up. But getting things in place before I want to buy my first share could make things easier when the day comes.
Months four to six: starting to buy dividend shares
At the start of month four in my 12-month plan, I would already have saved around £274. So I should soon be ready and able to start buying shares.
I could start by buying shares in a unit trust that tracked a leading share index such as the FTSE 100. Or I could invest in individual companies. Whatever I do, I would want to reduce my overall risk by diversifying across different companies and business areas.
For example, I may be attracted by the high dividend yields available by investing in tobacco. Imperial Brands, the maker of John Player Special, offers an 8.4% yield at the current share price, for example. In other words, for every £100 I put into Imperial shares, I would hopefully get £8.40 per year in passive income.
But what if something happens that leads to Imperial cutting its dividend? After all, it did that as recently as 2020. I could always invest in a second tobacco company at the same time, such as British American Tobacco. But what if there is a regulatory change or new tax that hurts profits across the whole tobacco sector? That is why I diversify not just between companies, but also across a number of different business sectors.
Months six to 12: growing passive income streams
Once I own shares, if they pay dividends then I would expect to get them for as long as I hold those shares. That is part of the reason for putting aside £3 a day can add up over time. If I bought £100 of Imperial Brands shares in the first year of my plan, I would not only hope for £8.40 of passive income the following year. I would hope to earn that much every year I held the shares even if I did not buy any more. In fact, if the dividend grew, my passive income streams could grow. That said, a dividend cut is also a possibility at any company.
Companies pay dividends on different timelines. Some, like Imperial Brands and British American Tobacco, pay quarterly. So by this point in my plan, I could well already expect to be receiving dividends from shares I had bought. I might use those dividends as passive income to spend. But I could also choose to reinvest it, hoping to increase my future passive income streams faster than I would do just with my £3 a day saving habit.
After a year of this plan, I ought to have almost £1,100 saved or invested in dividend shares. I will hopefully already be generating passive income as I go into the second year, although it may be modest. Investing a year’s savings of £3 a day in dividend shares with an average yield of 5% would hopefully earn me roughly £55 a year in passive income.
But to earn even a single penny, I need to take a practical step. That involves moving the 12-month plan off the drawing board and into action. The first day of those 12 months could be today!
The post Passive income with £3 a day? Here’s my 12-month action plan! appeared first on The Motley Fool UK.
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Christopher Ruane owns shares in British American Tobacco, Centrica and Imperial Brands. The Motley Fool UK has recommended British American Tobacco and Imperial Brands. 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.