Image source: Getty Images
Buying dividend-paying stocks is a simple but sometimes very effective way to generate passive income.
By doing that I could make the plan work for my own financial circumstances. By choosing how much to invest and then finding the right type of stock to buy, you could hopefully make money without having to work for it.
As an example, imagine you wanted to earn an average of £300 each month in passive income. This is how I intend to try to achieve that goal.
Saving within my means
You would set up a shares trading account, or stocks and Shares ISA, and then try to pay into it regularly.
One approach would be to simply do to this contributions when he had extra money. But let's take December as an example. There is often less money available this time of year!
By setting a regular savings goal, I could hopefully inject some discipline into building my funds while still following an approach that worked for my own financial circumstances.
Find stocks to buy
My next step would be to identify the types of stocks that may have the potential to meet my investment objectives.
Not all stocks pay dividends. If a company does not generate enough free cash flow, it can cut or eliminate the payment to shareholders.
Therefore, I would look for companies that I believe have a strong competitive advantage in a large and durable market. That could help them generate cash that could be used to pay a dividend and generate passive income.
Portfolio and prices
But even the most promising business can disappoint, so I would spread my portfolio across a wide range of stocks.
I like the juicy dividends of British American Tobacco, For example. But cigarettes are losing popularity, and that could hurt the company's cash flow generation potential. So he Stroke of luck Maker is just one of the income stocks I have in my portfolio.
I would also focus on not paying more than I thought a stock was worth, allowing for a margin of safety. If I overpay for the stock, I could end up losing more capital than I earn in dividends. That's the opposite of what I want to achieve!
Keep the goal in sight
How much I earn will depend on how much I have invested and what my average dividend yield is. That is the annual dividend I earn from a stock expressed as a percentage of its purchase price.
I could try to speed things up by reinvesting my dividends at the beginning (known as compounding) instead of using them as passive income.
For example, if you invested £100 per week with an average return of 7%, you could generate income streams of £300 per month in less than eight years. At that point (or any point along the way) you could stop compounding the dividends and instead withdraw them as passive income.
