One approach to generating passive income is setting up a small business — a side hustle — that requires virtually no money upfront but helps you earn money without working for it. The problem with that approach, as I see it, is that building such a business actually tends to involve a lot of work. It is anything but passive!

By contrast, many people put some money to work for them to earn even more money. So the income is indeed passive – but it requires capital.

Fortunately, that capital requirement can be low. Here is what someone could aim for with just £3 a day.

What ingredients are in this recipe?

Three quid a day might not sound like much, but it is a start.

Earning passive income by building a portfolio of dividend shares relies on three factors. One is having money to invest.

That daily £3 will start to add up. Indeed, one of the things I like about owning dividend shares as a way to earn passive income is that the plan can be tailored to one’s individual financial circumstances.

A second factor is time. The longer an investor saves, the more money there is to invest. That can translate to more passive income.

The third factor is what that money earns. This can be determined by the dividend yield of a portfolio. Yield is basically what is earned in dividends each year, expressed as a percentage of the cost of the shares.

Being a smart investor

Still, that does not mean it is necessarily a good idea simply to chase the highest yield. After all, dividends are never guaranteed. A high yield can be a red flag that the City expects a company to reduce or even cancel its dividend.

That explains why it makes sense both to diversify the portfolio and choose carefully what shares go into it. It also makes sense to try and keep dealing costs and commissions low by selecting a suitable share-dealing account, Stocks and Shares ISA or trading app.

Say someone invests £3 a day for 10 years, reinvesting dividends during that period, before taking them as passive income at the 10 year mark, even without investing another penny. At a 3% yield (what the FTSE 100 currently offers), that should lead to an annual passive income of around £377.

A 5% yield would mean that number was roughly £689. Or, at a 7% yield, £1,059.

One share to consider

I will stick with that 5% yield as one I think is eminently achievable in today’s market while sticking to blue-chip shares.

For investors without ethical objections to tobacco shares, one solid dividend payer I think merits consideration is FTSE 100 member British American Tobacco (LSE: BATS). It has grown its dividend per share annually for decades. The current yield is a juicy 5.8%.

In the past five years, the share price has grown a handy 52%, but despite that, I still think it is reasonable at 12 times earnings.

Declining cigarette consumption is a risk to the firm’s revenues – which have been falling in recent years – and profits. But its premium brand portfolio gives the Lucky Strike owner pricing power to try and mitigate declining sales volumes.

It remains a massive cash generator. That could help support the dividend in future.