One of my investing objectives is to create passive income. That way I don’t need to make constant investing decisions, which can lead to making more costly mistakes. Instead, I can just buy good shares, paying dividends and watch the passive income roll in. What a great feeling.
To get to a goal of having my monthly passive income exceed my employment earnings, I’d invest at least £250 per month in UK shares, though ideally more. This is how I’d invest that money.
Pick shares with high dividend cover and growth
Many investors might be tempted to pick high-yielding shares to create a passive income. I can understand why and I have a few such shares myself.
But I want my passive income to be for the long term and the risk with high-yielding shares is that the business may be struggling, or the payout is just too high to grow year after year. That could put pressure on the share price and lead to me as an investor losing money. Remember Warren Buffett’s number one rule about investing? “Don’t lose money“.
I’d prefer instead to focus on slightly-lower-yielding shares that have a good level of dividend cover. That means they should be able to increase the dividend each year, which is exactly what I want.
If they can combine that with a business model that should give them a competitive edge for decades to come, then that’s all the better for my passive income investing. I can just buy and hold such stocks and not have to worry about them.
Getting more passive income
I’d first invest my £250 a month in a diversified pool of FTSE 100 companies. Such companies are well established, they’ve risen to become the largest listed companies and have significant investor backing. Most FTSE 100 companies also pay a dividend.
Once I had FTSE 100 shares, I’d move on to the FTSE 250, the next 250 largest UK-listed companies. These businesses are more likely to combine reinvesting in growth with paying a dividend. The result should be greater share price growth, along with a growing, sustainable dividend payment to shareholders.
Then, once I have my mid- and large-cap stocks creating passive income for me month in and month out I’d potentially look for dividend-paying small-cap shares to diversify my portfolio and add the potential for capital growth. These kinds of shares could also be the big dividend-payers in the future.
This is my strategy for aiming to create a passive income that I can build up over time. I think it’s a realistic goal. It just requires a plan and consistency.
If I start with a lump sum of £5,000 and invest £250 a month. After a decade I might have £50,000+ if I achieved a 6% return a year. This would provide a modest passive income. Of course, with no lump sum to begin with, it would take longer.
And the risk is, of course, that my returns might be lower. That’s why choosing the right shares and doing research is so important. Another thing to watch out for is charges that could eat into my returns. So I’ll need to avoid buying and selling too often.
Andy Ross owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.
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