The idea of putting money into dividend shares to earn passive income is a very old one.
One reason it has hung around so long is precisely because it can work well. Another is its adaptability: it can be suited to the amount of money a particular person has to spare.
Let me run through some basics, to show what that might look like in action for someone targeting £750 per month of income.
Understanding the role of dividend yield
£750 per month equates to £9k per year.
If someone wanted to earn that in interest from a bank account, they would look at the interest rate to decide how much to invest.
The current Bank of England base rate is 3.75%. Now, deposit accounts may well offer less, but using the base rate as an example, £9k is 3.75% of £240k. So, someone targetting £9k per year of interest at a 3.75% rate would need to invest £240k.
In some ways, dividend yield works along similar lines – but with some important differences.
The current average FTSE 100 yield is 3%. But in today’s market, I think 6% is achievable while sticking to blue-chip businesses. At a 6% yield, a £9k passive income would take investment of £150k.
Dividends are never guaranteed, though. Come to that, interest rates can move around too.
These days it is unlikely that the money in a bank account will be wiped out through bank insolvency (the first £120k is typically covered by a compensation scheme at any rate). But share prices can move around in value.
That might be bad for the portfolio’s worth, if prices fall. But it can also be good in my view as prices can move up.
So, as well as passive income, someone investing in the stock market may also make a capital gain.
The mechanics of stock market investing
Before putting money into the stock market to try and generate passive income streams, an investor ought to learn about some of the key concepts involved. Those range from valuing shares to how fees and commissions can eat into financial returns.
Given the latter point, it makes sense to choose carefully when selecting a share-dealing account, Stocks and Shares ISA, or trading app.
One income share to consider
One dividend share I think is worth considering for its passive income prospects is FTSE 100 asset manager M&G (LSE: MNG).
The company aims to grow its dividend per share annually – and in this week’s annual results it did exactly that.
The current yield of 6.8% is well above the 6% target I mentioned above.
Dividend growth was not the only good news in the results. One risk that has troubled me about M&G in recent years is investors pulling more out of its funds than they put in.
But the company reported a £7.8bn net inflow last year into its open business (‘open’ because some of M&G’s funds are closed to new money). That is encouraging, though the risk still concerns me especially in volatile markets like those we are currently seeing.
M&G has a strong brand and large customer base, with £376bn of assets under management and administration. It is highly capital generative, which could help support ongoing dividend growth.
