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Free money for life! How I’d target £100 each month in dividend income

British pound coins in birds' nest

People often say that money does not grow on trees (although in the case of Woodbois at least, investors are hoping that growing trees can create money). But some things come close to being free money in my view.

Take investing in dividend shares as an example. I can potentially earn dividends from a company whose shares I buy. Such money is given to me free of charge.

However, to get those dividends, I do need to spend money in the first place buying the shares. I think that could be a smart financial move for me, as I could invest some cash now to receive free money for years or even decades into the future. Here is how I would go about it.

Dividend shares as a source of free money

The principle behind dividends is pretty straightforward. A company may generate some excess cash in any given year over and above what it needs to fund its business. It can decide to pay that out to shareholders, in the form of dividends. At that point, if I am a shareholder in the company, I will be in line to receive my own portion of the funds paid out.

But while the principle may be straightforward, the practice can be more complicated. Dividends are never guaranteed. Even a company that has paid them before and is profitable can decide to stop paying dividends.

That is why I would take care when hunting for shares, to try and find ones that I thought stood a good chance of paying me dividends in the future.

Shares to buy

To do that, I would look for a few clues.

Paying dividends requires a business to make enough money to cover the cost of them. So I would look for a business area that I thought was likely to see strong customer demand in future. For example, I expect banks like Lloyds and HSBC will continue to see strong demand.

But strong demand could attract a lot of competitors to a market, pushing down profit margins. So I also look for a company to have some competitive advantage that cannot easily be replicated. For example, there is only one Twinings tea brand – and it is owned by Associated British Foods. That can help the firm maintain a premium price on its line of tea.

I would also consider a company’s finances. Some businesses generate a lot of profits but need to use them for research and development, or to pay down debt. That could limit the firm’s ability or enthusiasm to pay dividends.

Hitting my target

If I wanted to target £100 of monthly free money in the form of dividends, how much would I need to invest?

That depends on the average dividend yield of the shares I buy. £100 a month is £1,200 per year. If I invested £24,000 in shares with an average yield of 5% I would hopefully hit that target.

I could start by investing less money, as long as I was willing to accept a lower annual dividend income. Crucially, however much I wanted to invest in shares, I would not focus just on dividend yield. First and foremost, I would look for shares with the qualities I described above, trading for an attractive price.

The post Free money for life! How I’d target £100 each month in dividend income appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Associated British Foods, HSBC Holdings, and Lloyds Banking Group. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.