Generating passive income is a financial goal shared by many investors. After all, who wouldn’t want to receive money without having to do anything for it?
While there are plenty of ways to generate passive income, from my experience investing in stocks is often the simplest and most sustainable.
So, here are my three steps to generating a passive income worth £300 monthly.
1. Preparation
There are lots of ways we prepare ourselves for investment. Perhaps the first place to start is by taking care of any outstanding debts. Servicing debt is just throwing good money away, especially with today’s interest rates.
Once I’ve cleared debts, then I can start thinking about opening an investment account — a Stocks and Shares ISA is a great place to start as it’s tax-free — and considering my contributions.
Nowadays it’s possible to start an investment journey with as little as £20. Commission-free trading platforms and the invention of fractional shares have made this possible.
I think £3 a day, or £100 a month, is a good starting point. It’s the cost of a daily coffee, and it will add up significantly over time.
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2. Stock picking
Buying and selling shares could not be more simple these days. We can use platforms like Hargreaves Lansdown, or ones with small fixed fees, to take immediate investment action.
Picking the right stocks can be the challenge. When we’re investing for passive income, it makes sense to pick dividend stocks. These are companies that tend to be more established, as their income is stable enough to reward shareholders, and this tends to make them a less risky proposition than trying to invest in the next Apple, for example.
A common mistake is investing in stocks with the highest dividend yield. After all, we want to achieve the biggest return we can right?
Unfortunately, very high dividends are often unsustainable or even a warning. We need to look at metrics like the dividend coverage ratio, and performance guidance to assess whether the yield is sustainable. Just take a look at Persimmon‘s 20% yield last year — it was cut!
For reference, the average among UK shares is around 3.7%. Some stocks, like Phoenix Group, have a track record of returning big dividends, but don’t offer much in the way of share price gains. Sometimes, there’s a trade off.
3. When to take passive income
It’s not going to happen overnight, especially if I’m starting from scratch. After investing £100 a month for four years, I’d likely have around £6,000 using some pretty rough calculations based on a fairly modest rate of return and reinvesting returns until that point.
And with £6,000 invested in stocks paying a 5% yield — like Lloyds and Barclays — I’d take home £300 a month in passive income.
