There are lots of ideas floating around about how to earn passive income – some much more passive than others. An old idea that is still successfully used by large numbers of people is buying shares in a range of blue-chip companies that look set to distribute some or all of their spare cash to shareholders in the form of dividends.

That is not always easy to achieve as hoped. For starters, dividends are never guaranteed. Even a company that has made generous payouts in the past can suddenly halt them.

Still, there are some simple steps investors can take to try and mitigate that risk, such as diversifying their portfolio and doing the proper research before investing in a company. So how lucrative can such an approach be?

Dividend yield: a simple but key concept to understand

The answer to that question depends on what is invested and at what average dividend yield. Dividend yield is what an investor earns in dividends each year, expressed as a percentage of what the shares cost them.

So for example, the current yield of the FTSE 100 index of leading British companies is 3%. Someone who invested £10k now at that yield ought to earn around £300 a year of passive income. That is equivalent to around £25 a month.

But although the FTSE 100 yields 3%, I think it is possible to target a higher yield while sticking to quality shares. At a 5% yield, for example, the £10k could earn £500 of passive income annually – roughly £42 a month.

Time’s the investor’s friend

Someone who invested a year ago would actually be earning a bit more, as the FTSE 100 has grown 18% in that time. So they would now be yielding closer to 3.5%.

There is another way that time can help an investor – by initially reinvesting dividends (known as compounding), they can seek to grow the value of their portfolio even without investing more money. That way, it could potentially generate higher passive income streams in future.

Getting ready to invest

For example, say someone invested £10k today and compounded it at 5% annually (which I think is a realistic target in today’s market) for 10 years. After a decade, it ought to be worth over £16k. At a 5% yield, that could earn some £814 a year in passive income – close to £68 a month.

To do that, someone needs a practical way to invest. For example, that may be a share-dealing account, Stocks and Shares ISA or trading app.

Finding shares to buy

The investor also needs to find some dividend shares to purchase! One I think merits consideration is consumer goods giant Reckitt Benckiser (LSE: RKT).

Its current yield is 4.2%. Although dividends are never guaranteed, I am attracted by Reckitt’s cash flow generation potential. The company’s portfolio of premium brands such as Finish and Gaviscon give it pricing power and exposure to product categories where customer demand is resilient.

Still, the Reckitt share price is down 14% over the past year.

I think that increases the share’s attractiveness, but it points to a risk too. Investors are nervous about the ongoing impact of a disastrous infant nutrition acquisition on Reckitt’s finances. From a long-term perspective though, I see a lot to like here.

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Christopher Ruane does not hold any positions in the companies mentioned.