Wouldn't an extra $500 a month in passive income be nice? Unfortunately, there are no easy solutions to the problem of gaining a stream of secondary income of this size. But fortunately, ASX shares can provide a clear pathway to this goal, if not a short one.
So today, I'll walk you through my five-step plan to secure a $500 per month stream of passive, dividend income from ASX shares.
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A 5-step plan to building $500 a month in passive income from ASX shares
Step 1: Knowledge is power
The first step in this journey is understanding exactly how ASX shares can help you build a source of passive income. It is common to hear shares spoken about in terms of ticker codes, charts, and 'picks'. But a better way to view a share is as a piece of a business.
Buying shares is really investing in the fortunes of a company. Buy the right company, and you share in its prosperity. Buy the wrong one, and well… we know what can happen.
The vast majority of ASX shares pay their shareholders dividends regularly. A dividend is a cash payment made to shareholders by the company as a way of encouraging ownership and rewarding investors.
Most companies' dividends fluctuate from year to year, but the best ones tend to raise them consistently over long periods of time. Accumulating more and more of the best dividend shares should lead to more and more passive dividend income.
Step 2: Getting your house in order
Understanding dividend investing is one thing, but preparing your finances to be able to build up a stream of passive income is another. Everyone's personal financial circumstances are different of course.
But as a good rule of thumb, you should not be investing until you have cleared any personal debts you may have (such as credit cards or personal loans), and you are in a position to save more of your income than you spend.
Only once you have your personal budget 'in surplus', and you have enough money stashed away for a rainy day, you should be thinking about deploying additional funds into building a secondary income.
Step 3: Choosing your ASX dividend shares
This is probably the hardest step of them all. Investors in dividend-paying shares should probably follow the same 'best practice' rules as any other investor, especially building a diversified portfolio of different shares. Just investing in the big banks, for example, exposes you to any issues that might only affect the banking sector.
So most investors should aim for a diverse grouping of the best businesses across different sectors. Those might include high-quality names like Washington H. Soul Pattinson and Co Ltd (ASX: SOL), Brickworks Ltd (ASX: BKW), Coles Group Ltd (ASX: COL), and Telstra Group Ltd (ASX: TLS).
If that all sounds overwhelming, an alternative path is to pursue index exchange-traded funds (ETFs) like the Vanguard Australian Shares Index ETF (ASX: VAS). ASX index funds hold the largest 200 or 300 shares on our markets, giving you automatic diversification.
These funds have to pass on any dividend income they receive too, so you will get what could be called an average of all the dividends that the Australian share market is paying out every year.
Step 4: Build your passive income snowball
Once you have found your ideal dividend-paying shares, it's time to get buying. Remember, the dividend yield you can expect from a company will rise as its share price falls. So it's usually better to buy your favourite companies at the cheapest price you can.
Then, it's just a case of rinse and repeat. When one starts out investing, it can be a little discouraging seeing your first dividends come in when you are getting a few dollars at a time. But if you relentlessly plough any surplus capital into buying ever more dividend shares, it should snowball. Make sure you reinvest your dividends back into buying more shares every time too – that will make a huge difference as the years tick by.
Step Five: Patience, grasshopper
The final step is both the easiest and hardest: waiting. Building up a dividend income stream takes even the best investors many years. To get to $500 a month, you will need to have a total of $150,000 in invested capital if you are getting an average yield from your shares of 4%.
But, although this is a tough ask, it is doable. If one invests $500 every month, reinvests dividends, and can get an average return of 7% per annum, then getting to $150,000 will take just over 15 years. If you can manage $1,000 a month, then this timespan drops to under a decade.
