There are many reasons to invest, whether that be in ASX shares or not. Some people do it to try and get as wealthy as possible, as soon as possible. That's a dangerous road to travel. Others just do so to build wealth, period. But many invest to build up a stream of passive income.
The appeal of a second income is obvious. Who wouldn't want more money? Not to mention a financial lifeline if one loses their primary source of income.
How to build a second income
There are many ways of building a stream of passive income. You can pen a book or write music. Start a podcast or a business. Of course, all of these potential sources of second income require initial work. But they could, in theory, become true passive income over time, income that pays you whether you work or not.
I prefer the passive income sources that require little to no upfront labour though. And that narrows our potential candidates down significantly. One possible avenue is property investing. But, as we all know, that requires an enormous amount of cash to get going. Plus, it can take many years to actually yield meaningful income.
That leaves ASX shares. As we've discussed before, I think shares are one of the best places to build a second source of income. There are the considerable tax advantages to consider for one, which include the benefits of franking credits that come alongside most ASX dividends.
But ASX shares give us the perfect source of passive income since they require relatively little ongoing labour on our behalf.
But that isn't to say that investing in ASX shares for passive income is easy. For starters, getting your head around how the share market and investing in stocks works can be daunting. Not to mention choosing the right shares to provide you with the actual income itself.
After all, many an investor has been burned by trying to buy up what looks like a lucrative dividend share, only to have it cut its dividends down the road.
So I have two tips for those looking to build a second income using ASX shares.
How to pick ASX shares for passive income
Firstly, you can start simple. Instead of picking an individual stock, you can opt for broad, diversified investments that have comparatively far less risk than a single company. Index funds or exchange-traded funds (ETFs) are a great place to start.
These usually hold a vast basket of underlying shares, most of which are blue chip companies with significant size and scale. Two popular choices include the iShares Core S&P/ASX 200 ETF (ASX: IOZ) and the Vanguard Australian Shares High Yield ETF (ASX: VHY).
You can also go for a listed investment company (LIC) like Argo Investments Limited (ASX: ARG). These have been around for a very long time, and are very useful if you just want a hands-off, bottom-drawer investment you can count on for reliable income.
Secondly, if you do want to pick individual dividend stocks for passive income, always look at the company's past, as well as think about its future. The first questions I ask myself when looking at a potential passive income investment have nothing to do with cash flow statements or balance sheets.
Rather, it's 'has this company consistently delivered good returns and meaningful dividends in the past'. Next, it's 'will this company be larger and stronger in ten years than it is today'. If the answer to both of those questions is a yes, then you might be onto a winner.