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Passive income involves earning money without working for it.
Nice in theory, but not always so actionable in practice.
For example, one approach to creating passive income streams is to set up an online retail business and then earn money from sales. But to my mind, setting up an online business (let alone managing it) is not truly passive at all.
By contrast, many investors put their money into businesses like Next or Sainsbury that have already shown they can make profits — and then earn passive income in the form of dividends from those shareholdings.
Dividends can be lucrative!
Dividends are a way for a company to distribute some (or all) of its spare cash among shareholders.
They are never guaranteed. That is why a savvy investor diversifies their portfolio among different shares.
The average dividend yield of the FTSE 100 right now is 3.3%. That means that each £100 invested will hopefully earn £3.30 in passive income each year.
But I think a higher yield is possible while sticking to blue-chip dividend shares. Let’s say 5%.
£5 a day is £1,825 per year. Investing at a 5% yield, that ought to earn around £91 of passive income per year.
Taking the long-term approach
Those dividends could keep flowing for years or even decades after the initial investment.
But things could get even better!
If the investor keeps putting in £5 a day for a decade, compounding (reinvesting) the dividends along the way, after a decade they ought to be sitting on a portfolio worth over £23,000.
At a 5% dividend yield, it should earn annual passive income of around £1,174.
Such is the power of taking a long-term approach to investing, even on a modest budget.
Starting to put the plan into action
Of course that daily £5 needs to be put somewhere where it can be used to buy shares.
So a useful, practical first step is selecting a share dealing account, Stocks and Shares ISA, or trading app.
Finding shares to buy
As I said above, I do not think 5% is a particularly challenging target, even while sticking to proven blue-chip businesses.
One share I think investors ought to consider is FTSE 100 insurer Aviva (LSE: AV).
The share has recently hit its highest price for over a decade. But despite that – and a dividend cut in 2020 – it still yields an attractive 5.5%.
The company aims to grow its dividend per share each year. I am optimistic it can do so because it has a highly cash generative business focused on the UK insurance market and is aiming to build on its strengths.
It is already the nation’s largest insurer by some distance. Moves such as acquiring rival Direct Line should help it build further economies of scale.
Aviva has long experience in the insurance market, helping it operate its business profitably. But rivals would love to take some of its market share and I see a risk that any serious price competition could eat into its profit margins.
Demand for insurance is set to endure, though. As the market leader, I see Aviva as well-placed to benefit from that.
