Disclaimer: This isn’t investing advice. I am simply sharing what I’ve experienced through my investments over the years in the Australian Stock Exchange (ASX).
Please consult an investment professional that can provide you with financial investment expertise.
Back when I was just finishing high school, I started to get introduced to the concept of making money and passive income. After reading the book Rich Dad, Poor Dad, I became familiar with shares offering one option for earning income passively.
To set the scene, I had no money. I was broke and I wasn’t working. So even though the concept of passive income from stocks and shares sounded good, it didn’t seem like it was possible for me at the time.
What I will describe is how I was able to work my way to building a shares portfolio that would allow me to earn passive income in the future.
I will also share some insights that you should also consider if you plan to use stocks and shares as a method for earning passive income.
How can you earn passive income from shares?
To my knowledge, there’s a couple of ways you can earn passive income from shares.
Earn dividends from the ownership of the shares.
The first is from earning dividends from the ownership of the shares. What this means is the company that you hold the shares for will payout a percentage of their profit based on the amount of shares that you own.
From the shares that I’ve owned, the income paid out to me tends to range between $0.08-$0.40 per share.
So if I own 1000 shares, I will be paid $80-400.
Earn income from an Options contract on the shares.
I typically aim to own at least 1000 shares, which will allow me to have have the option to write an Options contract on the shares. This will give me the option to write Call or Put options on the shares, which will allow me to earn a fee for selling the shares to buyer at a future price.
This might mean I will lose out on some future profit. But I can plan to earn enough of a profit and let the future buyer earn the excess profit, in exchange for receiving a guaranteed fee.
Additionally, if the price of the shares fall, it guarantees that I can sell the shares at a price that is above the value of the market.
What else can you earn from the ownership of the shares?
You can earn an income from the sale of the shares in the form of capital gains.
In order for you to profit, the sale price of the shares that you bought needs to be higher than when you bought the shares.
For example, I had Virgin Blue shares when they were originally floated on the stock market. From memory, they floated at $7 a share. I then sold it at $7.50 a share. So I made a gross profit of $0.50 for every share that I owned.
At the time, I owned approximately 1000 shares. So my gross profit was $500.
What are some of the things that you need to consider when buying shares for passive income?
Your money will be tied up in the shares.
Owning shares requires you to invest money into the asset. Once this is invested, you won’t be able to do anything with the money until the shares a sold and you receive the cash.
It’s easy to sell the shares if the price of the shares have risen. However, when the price is lower than what you bought them for and your equity value is at a loss, you will be forced to hold onto the shares until the value in the shares have risen.
This can potentially accelerate and multiply your losses, should the share price start to decline.
You will need to pay tax on the income that you’ve earned.
The taxation office will dictate how much tax they will take from the income that you will generate from shares.
You can lose more money through equity losses.
The payoff period may be long.
I like to look at the payoff period of the shares. Essentially, if you buy existing stocks or shares that’s already providing an income, you will generally pay a premium for the existing income that is being generated.
From the shares that I’ve invested in, I typically find the gross ROI to be 3-5% per annum of the original purchase price.
This means it will take at least 20 years for the passive income to breakeven. From year 21, I would actually start making profitable passive income.
The dividend amount depends on the management and company performance.
The management of the company will determine the company’s performance and dividend payout. Bad management will lead to poor profitability. And poor profits reduce the chances of you receiving any income through dividends.
On top of this, the management of the company will affect the share price value and the income that you can earn through the sale of your shares or even income from option contracts on the shares.
You need to look carefully at the management team, structure, and operations for the company to assess the chances of the business improving their profitability during the time that you plan to own the shares.
What is this passive income strategy good for?
In my opinion, if you would like to own an asset that produces future income, then this can be a good asset to own. You don’t need to do any management. You simply need to own the asset and have it produce an income for you.
Extra income on top of what you are already earning from employment.
If you would like to earn additional income that you can put towards annual spending such as a holiday getaway, then this can be a great investment tool.
You can use the dividend income to pay for items such as holidays or gifts for yourself.
Use shares as a tool to build future wealth.
You can invest in shares to use the income from the dividends to purchase more shares. This will see the value of your investment compound, so that when you sell the shares in the future, you will be able to receive a lump sum payment.
How can you start earning income from shares?
You need to have cash.
You need cash to purchase the shares. There are a few options for getting the cash and you will need to check the permissions that you can have in order to buy the shares.
The first is to save enough money to buy the shares. Your initial target should be for at least $500 worth of shares. Ideally, you will be able to afford to purchase 1000 shares.
If you cannot, invest in $500-1000 increments and let your investment build up over time.
Alternatively, you can take out a small loan for the investment and you can purchase the shares. The only thing is you will need to use the income from the shares to pay back the loan unless you are able to profit from the interest rate.
Should you go with this option, you will want to strongly consider using additional income and protections with call and put options to protect you from losses that you can be exposed to.
This will also provide you with income that you can put towards the payment of the loan on the shares.