Earning passive income doesn't have to require a lot of work.
Sure, you'll need to establish your sources of passive income, but once this is done you can sit back and relax as the benefits roll in.
The great thing about passive income is that you don't have to work a 9-5 job to earn it – you can even earn passive income while you sleep!
Developing a passive income stream means you can free up your time so you can devote it to the things most important to you.
What is "passive income"?
Passive income is income that takes little to no effort to earn i.e. you don't have to actively 'work' to earn it. Examples of passive income include interest earned on your savings account, rental payments from an investment property, and dividends from ASX shares.
Of course, there is some work involved in setting up the source of your passive income, but once this is done your earnings require little to no work to maintain.
Earning passive income through ASX shares
One of the most popular ways of earning passive income is through investments in ASX shares.
The benefit of earning passive income through ASX shares is that you don't need to deal with tenants or a mortgage (unlike property) and your dividends will likely be higher than what you could earn from a savings account.
Shareholders are entitled to a proportion of company profits paid in the form of dividends. However, not all ASX shares make profits, and of the ASX shares that do make profits, not all will distribute them to shareholders.
If you want to generate passive income, you'll want to invest in ASX shares with a history of paying regular and reliable dividends.
These are often mature companies with stable earnings that don't need to reinvest as much in themselves. By contrast, early-stage companies will often reinvest profits to drive future growth instead of distributing them to shareholders.
Tax benefit of receiving dividends
One benefit of receiving passive income through dividends in Australia is that dividends can be 'franked'. This means that the dividends are paid from profits which the company has already paid tax on.
Shareholders receive franking credits for tax paid. Franking credits can then be used to offset your personal income tax.
How franking credits work
The Australian company tax rate is currently 30%. If you receive fully franked dividends and your top tax rate is less than 30%, you'll receive a refund from the tax office for the difference. If your top tax rate is higher than 30% you'll get a credit for the tax already paid by the company.
'Grossed up' dividends are calculated by adding the dividend amount and the franking credits.
Dividends can be fully franked (where the company has paid the full 30% company tax), partly franked (where the company has paid part of the company tax), or unfranked (where the company has not paid company tax).
By grossing up dividends, you can make a comparison between dividends with different levels of franking.
How to earn $1,000 per month investing in ASX shares
To earn $1,000 of passive income a month from ASX shares you'll need to invest around $200,000 in ASX shares that have an average grossed-up dividend yield of 6%.
This gives you $200,000 x 0.06 = $12,000 in passive income and franking credits a year.
Of course, you'll want to invest in a variety of ASX shares rather than just one or two to achieve this. It's important to diversify the source of your dividends so your passive income isn't dependent on the fortunes of just one or two companies.
Putting together a passive income portfolio
We have put together a portfolio of 10 ASX shares with grossed-up dividend yields of around 6%. By investing $20,000 in each, you can earn $1,000 a month in passive income from dividends.
As a bonus, you can also benefit from capital gains if the share prices of the companies increase.
10 ASX shares to buy to earn $1000 per month in passive income
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AGL Energy Limited (ASX: AGL)
AGL Energy is an energy provider with traditional thermal electricity plants as well as renewable energy sources including hydro, wind, and solar power. AGL has a dividend yield of 5.27% with a grossed-up dividend yield of just over 7%.
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Ausnet Services Ltd (ASX: AST)
Ausnet Services owns the Victorian electricity distribution network and one of three gas distribution networks in Victoria. Ausnet has a dividend yield of 5.63% and a grossed-up dividend yield of 6.72%.
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Commonwealth Bank of Australia (ASX: CBA)
Commonwealth Bank of Australia is a financial services provider providing banking, funds management, superannuation, insurance, and broking services. CBA has a dividend yield of 4.92% and a grossed-up dividend yield of 7%.
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Crown Resorts Ltd (ASX: CWN)
Crown Resorts is a gaming and entertainment business with resorts and casinos in Australia, Macau, and the UK. Crown has a dividend yield of 5.12% and a grossed-up dividend yield of 5.67%.
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Metcash Limited (ASX: MTS)
Metcash is a wholesale distribution and marketing company operating in the food, liquor, and hardware sectors. Metcash has a dividend yield of 4.68% and a grossed-up dividend yield of 6.68%.
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National Australia Bank Ltd. (ASX: NAB)
National Australia Bank is a financial services group that provides banking and wealth management services across Australia and New Zealand, with branches in Asia, the US, and the UK. NAB has a dividend yield of 6.1% and a grossed-up dividend yield of 8.68%.
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Nine Entertainment Co Holdings Ltd (ASX: NEC)
Nine Entertainment is a media company with television, print, digital, and video on demand interests. Nine Entertainment has a dividend yield of 5.68% and a grossed-up dividend yield of 8.12%.
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New Hope Corporation Limited (ASX: NHC)
New Hope Corporation is a coal, oil, and gas producer with exploration tenements in Queensland. New Hope has a dividend yield of 9.65% and a grossed-up dividend yield of 13.78%.
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Star Entertainment Group Ltd (ASX: SGR)
Star Entertainment Group operates in the entertainment and leisure industry with casinos in New South Wales and Queensland. Star Entertainment has a dividend yield of 4.99% and a grossed-up dividend yield of 7.13%.
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Woodside Petroleum Limited (ASX: WPL)
Woodside Petroleum is an oil and gas company with a portfolio of assets both in Australia and offshore. Woodside has a dividend yield of 4.06% and a grossed-up dividend yield of 5.8%.
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Foolish takeaway
It's important to remember that once you've done the initial work to set up your portfolio of ASX dividend shares, the money won't simply come raining in.
Earning a passive income by investing in ASX shares won't make you rich overnight, and some level of patience is required in the early days. But if you stick with it, over time these dividends can become profitable – and as you earn more in dividends, you can reinvest them back into your ASX shares, resulting in even more dividends in future.
So there you have it – by having patience, reinvesting your profits and letting the miracle of compounding returns weave its magic, you could be relaxing at the beach while earning a tidy passive income from your ASX shares.
All figures quoted correct as at 19 February 2020.
