I’ve been investing in shares since 1986/87, so I’ve had at least 35 years in the market. During these decades, I’ve made almost every investing mistake it’s possible to make — and then some. As a result, my investing strategy has become very clearly defined over time. And what works for me today is buying dividend shares to generate passive income.
Here’s how I’d build passive income today
I’m 54 and have been investing since my late teens. But what if I was starting out from scratch today, with my whole life ahead of me (instead of mostly in the rear-view mirror)? Here’s what I’d do.
Step 1: Pay myself every month
The first of my three steps would be to pay myself. In other words, I’d set aside an affordable sum of money each and every month, earmarked solely for investing. So I’d pay all my bills, work out how much I needed for everyday expenses, and then set aside most of the remainder to build me a brighter future.
I can’t tell you how ridiculously hard this simple step proved to be for me. To be honest, it took me years to get used to budgeting with an eye on my future. Eventually, I set up a direct debit or standing order to snatch money from my bank account on payday, preventing me from splurging it elsewhere.
Step 2: Buy shares every month
Obviously, the next step is to start actually investing my spare cash into dividend-paying shares. By doing this, I become part-owner of a business, which means that I share in its future profits and success. And if the company does well, so do I. Thus, shares are not lottery tickets!
Also, by reinvesting my cash dividends into yet more shares, I turbo-charge my future returns, helping to boost my wealth. And when the time comes (for me, pretty soon), I can switch to using this passive income to replace my earnings as I wind down towards retirement.
Step 3: Build my passive income
Having based my strategy on passive income, it makes sense to maximise these unearned amounts. Alas, not all shares pay dividends — the regular cash payments made to shareholders, typically half-yearly or quarterly. But almost all members of the blue-chip FTSE 100 index do pay dividends.
What’s more, future dividends are not guaranteed, so they can be cut or cancelled at any time. This happened often during 2020’s Covid-19 crisis. But dozens of London-listed shares offer yearly dividend yields of 5% and more.
Take, for example, shares of Anglo-Australian mega-miner Rio Tinto (LSE: RIO). I own these shares because they offer one of the highest dividend yields in the UK. At the current share price of 5,392p each, their current dividend yield is 9.8% a year.
Hence, to generate passive income of £500 a year, I’d need to invest 500/0.098 = just over £5,102 into Rio Tinto shares. And if I couldn’t afford to do this in one go, I could spread it out into, say, £255 a month for 20 months. And then I’d move on to buying a different high-yielding share.
Eventually, over the years, I’d build a carefully diversified portfolio of many dividend-paying stocks. And then I’d use this passive income to enjoy a happier and more rewarding life!
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