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Here’s how I’d invest £10,000 in dividend shares to target a £700 income annually

UK money in a Jar on a background

Owning dividend shares can be a lucrative source of passive income. Simply by investing in a few well-known companies that divvy up some of their profits among shareholders, I can hopefully earn money regularly without having to work for it.

If I had a spare £10,000 to invest right now, here is how I would use it to target annual income of £700. Over the years, hopefully, that sum could increase if dividends grew.

Start with the end in sight

If I want to earn £700 in annual dividend income from a £10,000 portfolio, I will need to achieve an average dividend yield of 7%.

I do not start investing by looking at yield. Instead, I look for great businesses selling at attractive prices. If I can find such firms though, I would then look at their dividend yield.

Building a portfolio

Right now, there are a few companies I think match my investment criteria that could help me achieve that average yield. From the FTSE 100, for example, I might choose British American Tobacco, M&G and Legal & General.

Note that I am thinking here in terms of a range of shares, not just concentrating my money in what I see as the single best investment idea. That is because I think diversification is a critical risk management tool for investors. £10,000 is ample to diversify. I could split it evenly across five different shares, for example.

Avoiding yield traps

But sometimes, high-yielding shares can make me nervous as an investor. The yield might be a red flag that investors expect the dividend to be cut, for example.

M&G currently yields 10%. That seems unusually high to me compared to most shares on the London Stock Exchange. The company’s policy is to try and maintain or raise its annual dividend. M&G raised its interim dividend this year. It has also bought back £500m of its own shares this year. That means that, with fewer shares in circulation, it could pay a higher dividend per share than before, without needing to spend more money.

Still, is the 10% sustainable? After all, dividends are never guaranteed. So I look at how robust a business is, what competitive advantages it enjoys and what its free cash flows look like. Ultimately though, I can still make mistakes – or circumstances can change. That is why I keep my portfolio of dividend shares diversified.

Letting dividend shares do the work

Once I have invested the £10,000, what should I do?

I am a long-term investor, not a trader. So I would simply sit back, put my feet up and, hopefully, let the dividends roll in. If the companies do well and grow their payouts, in time I may earn even more than my target £700 in passive income each year.

I would keep an eye on the shares from time to time, paying attention to anything that I felt changed the investment case for them. But rather than jumping in and out of the markets frequently, I would adopt a genuinely passive approach while the dividends started to pile up.

The post Here’s how I’d invest £10,000 in dividend shares to target a £700 income annually appeared first on The Motley Fool UK.

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C Ruane has positions in British American Tobacco P.l.c. and M&g Plc. The Motley Fool UK has recommended British American Tobacco P.l.c. 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.