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One way to earn passive income is to invest in blue-chip companies that pay dividends to shareholders.
Not all companies do this, but many do. In fact, FTSE 100 Index Companies currently pay Tens of billions of pounds every year shareholders. Therefore, buying carefully selected stocks can be a way to earn income from the success of such companies, without having to work for it.
If I had £8,000 to spare and wanted to put this passive income idea into practice, here's how I'd do it.
Getting ready to buy stocks
My first step would be to deposit the £8,000 into an account that I could use to buy shares.
So if you don't already have one, I would open a share trading account or a stocks and securities ISA.
How to Find Dividend stocks to Buy
My next step would be to learn how the stock market works.
Being able to read a company's balance sheet and accounts can help me see how the company is doing financially. I can then use my judgement to predict what might happen in the future when it comes to the dividend. For example, I consider how big a company's potential market is and what sets it apart from its rivals in that market.
In other words, I first look for what I consider to be great companies with great future potential and consider their valuation. Only then do I start to weigh up the attractiveness of the potential dividend compared to other options.
Instead of putting all my eggs in one basket, I try to reduce the risk of a disappointing investment by spreading my money across different stocks. £8,000 would be enough for me to do that.
An example in practice
To illustrate this approach, I can point to one of the stocks in my passive income portfolio: M&G (LSE: MNG).
From a pricing perspective, the asset manager has not performed impressively. Since it was listed on the London market in 2019, its shares have fallen by 9%.
But the dividend yield is 9.6%, meaning if you invested £100 today, you'd hopefully earn £9.60 in passive income each year.
M&G aims to maintain or increase its dividend per share annually, although, as with any stock, this is not guaranteed. I expect the asset management industry to benefit from resilient demand over the long term.
With a strong brand, a large customer base and deep asset management expertise, I believe M&G could continue to generate the levels of excess cash it needs to sustain its generous dividend.
But it is a competitive industry and if management performance is weak there is a risk that clients will withdraw their funds, which would hurt M&G's profits.
Aiming at a target
In practice, M&G's performance is well above the average of its FTSE 100 peers, but in the current market I think I could realistically aim for an average return of 7% whilst sticking to blue-chip companies with good reputations.
A 7% return on £8,000 equates to £560 per year. However, to increase my passive income, I could reinvest the dividends initially.
Doing that for a decade should mean you'd be earning around £1,100 a year in passive income within 10 years.
