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Owning blue-chip shares is one of the ways millions of people, including myself, aim to earn passive income.
That approach lets me benefit from the well-established and profitable businesses of companies like Vodafone without having to do any of the work myself.
It can also be highly lucrative, as long as I am patient and willing to adopt a long-term approach to investing.
Buying shares to set up passive income streams
How does spending £20k on shares practically give me the chance to earn money?
The answer is, it depends what shares I buy.
Some companies, like Google parent Alphabet, do not pay any dividends at all, as they prefer to keep money inside the business to fund growth.
Others are further along the path. Take Apple as an example. It does pay a dividend, but the yield of 0.6% means that if I invest £100 in Apple today, I would only receive 60p per year in dividends, if the payout is maintained at its current rate.
Then there are more mature businesses with limited growth opportunities for which they need lots of cash.
Take insurance company Phoenix as an example, with its stonking 9.5% yield. Admittedly the shares have fallen 19% in five years, while Alphabet and Apple have risen 138% and 223% respectively. But while limited growth opportunities at a proven business can hurt its share price, it can also set the stage for bumper dividends.
Setting up my portfolio
My first move would be to put the £20k into a share-dealing account, or Stocks and Shares ISA, so I would be ready to invest as soon as I found shares I liked.
Next, I would line up a shortlist of high-quality shares I wanted to buy.
Like legendary investor Warren Buffett, who has set up passive income streams stretching to billions of pounds annually by investing in dividend shares, I would stick to areas I felt I understood and could assess.
Rather than put all my eggs in one basket, I would spread the money evenly across five to 10 shares. There is no rush in long-term investing. If I could not find enough shares at an attractive valuation now, I would not rush to invest all my money.
Finding shares to buy
How would I choose? A dividend is never guaranteed. Phoenix may pay 9.5% now, but whether it does so will depend on whether its business can generate enough free cash flows to fund such a dividend – and whether its directors continue to see that as a good use of such money.
So I would spend time studying company accounts.
Hitting my target
A 9.5% yield is unusual, although not exceptional. Other FTSE 100 firms besides Phoenix have a yield of 9%, or higher, at the moment, including M&G and Vodafone.
But imagine I had a more modest target, say 7%. In one year that should earn me £1,400 of passive income from my £20k.
Instead of taking that as cash though, I could reinvest it in more shares (known as compounding).
Compounding my £20k at 7% annually, after 32 years my portfolio would hopefully be generating an average monthly dividend income of over £1,000.
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