The Motley Fool

How you could create a passive income snowball with dividend-paying shares

Passive income is a dream for many. Sending your money out to work so that it can grow over time and multiply itself, until one day, you don’t have to work anymore.

It’s a nice dream, but few follow through with it. That’s a shame because it’s actually a very simple process. Creating a passive income from shares is very doable for most Aussies – all you need is a job. Once you’ve got that sorted, just follow these simple steps…

Step One – Spend less and save more

I know this is about as popular as eating vegetables, but it’s essential to building your snowball. The less you spend, the more that’s left over for investing. If we all look hard enough and are honest with ourselves, there’s usually plenty of fat we can trim away from our lifestyles.

Step Two – Choose your investments

In my mind, the best way to build passive income is in dividend-paying shares. You might decide to start building a portfolio with a mixture of blue chips like Transurban Group (ASX: TCL) and Wesfarmers Ltd (ASX: WES), with some higher growth companies like SEEK Limited (ASX: SEK) and ARB Corporation Limited (ASX: ARB).

Or if you prefer the hands-off approach, you could equally choose a low-cost listed investment company like Argo Investments Limited (ASX: ARG) or an index fund such as Vanguard Australian Shares Index ETF (ASX: VAS) – listed asV300AEQ/ETF on Google Finance.

Once you’ve settled on where to invest, start buying. Don’t put it off. Don’t wait until the market gets ‘cheaper’. Just do it.

Step Three – Reinvest your dividends

If you’ve chosen sensible investments, you’ll now start receiving some lovely cash dividends. It’s important to make sure you reinvest your dividends, into new investments or exactly the same shares. As long as you do it. Otherwise, the miracle of compounding will be diluted.

Now is the time to put this new cash to work and make it earn even more income. Combine this with your continued savings and get the passive income snowball rolling.

Step Four – Track your passive income progress

Make a note of how much dividends you’re now earning with each new purchase and reinvestment. Tally it up and watch it grow. You’ll notice a few things happening…

Every time you buy more shares, your passive income will increase. Every time you reinvest your dividends, your passive income will increase. And every time your companies raise their dividends (which is most years), your passive income will increase.

With progress like that, it’ll be near impossible not to feel motivated to keep going. And don’t worry about tax, because franking credits will cover the majority of tax payable in many cases. Besides, having a flow of dividends which gets ever-larger is one of the better problems you can have.

Foolish takeaway

Here’s the bottom line: the more you save and invest, the faster your dividend income will grow, and the sooner it will cover your living expenses. So get started today, and create your own passive income snowball.

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Motley Fool contributor Dave Gow owns shares of ARB Limited, Argo Investments Limited, SEEK Limited, Transurban Group, Vanguard Australian Shares Index, and Wesfarmers Limited. The Motley Fool Australia owns shares of and has recommended Transurban Group and Wesfarmers Limited. The Motley Fool Australia has recommended ARB Limited and SEEK Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.