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What’s the best passive income idea? Depending on who you ask, you may well get a lot of different answers. Personally, one of the passive income ideas I like (and use) is investing in the stock market. Specifically, that involves buying shares in proven blue-chip businesses I hope can pay me dividends.
That can earn a lot of passive income, or just a little. It can also require a lot of cash for investing, or just a little. In other words, this flexible approach that can be tailor made for someone’s financial situation and passive income goals.
How shares generate passive income
Not all shares pay dividends and they can be cancelled at any time. So it is important to understand the mechanics of how this approach works.
The amount an investor earns depends on how much they put into shares and at what average dividend yield. Yield is basically the amount of dividends they should earn in a year, expressed as a percentage of what they pay for the shares.
So for example, a yield of 5% means an investor putting £100 into the stock market ought to earn £5 of dividends a year.
Where does the money for dividends come from? A company needs to generate enough spare cash and then can decide whether to pay dividends, or use such cash for something else.
So when on the hunt for shares to buy, I look at a company’s business model and balance sheet. I then try to assess how likely it is to pay dividends in the years to come.
Targeting a specific income
I explained dividend yield above. Say someone wants to target £50 a day of passive income from dividends. That is £18,250 a year.
To keep things simple for explanation, imagine a 10% yield. That would require investing £182,500 in the stock market to hit that target.
However, I do not see 10% as a realistic target for blue-chip shares in today’s market, when the FTSE 100 yields 2.9%. But I do think a 6% goal is credible. That would require investing around £304k in the market. That could be done in one fell swoop (which is unlikely for most of us) or through regular contributions — even small ones — building up over time.
With less money, the same plan could still work, but it would generate less passive income.
An income share to consider
A good start would be setting up a Stocks and Shares ISA or share-dealing account.
One income share I think investors should consider at the moment is asset manager M&G (LSE: MNG), with a 6.6% dividend yield. The company aims to grow its dividend per share each year (something known as a progressive dividend policy) and in recent years it has done that.
Demand for asset management is high and likely to stay so over the long term. I reckon that with its strong brand, international reach and customer base in the millions, M&G has some serious ongoing cash generation potential.
One risk is that choppy markets could lead policyholders to pull out funds. In recent years, the firm has sometimes struggled with the challenge of clients pulling more money out than they put in to its funds.
As a long-term investor though, I am upbeat about M&G’s prospects.
