I invest in UK shares with dividend offerings, either to supplement my income now or to build wealth for the long run, depending on my needs at the time.
But it’s normally the case that I don’t need my dividend payments, and instead I reinvest them. In fact, I pay in monthly to increase my pot of money available for investments.
Today, I’m looking at how I can turn investments of just £1,200 a year into a second annual income worth £4,000 a year.
The importance of regular investment
I’m fortunate in that I rarely need the dividends I receive from my investments right now. So I reinvest them every year. It might not sound like a winning strategy, but it really is.
Regularly topping up my investments with as little as £100 a month can have a huge impact in the long run. After 30 years of putting £100 in to a share-dealing account, I’d have at least £36,000 put aside, even if I hadn’t invested in anything. But through regular investment I can benefit from something called compounding returns.
Compounding returns
Compound returns is the process of earning interest on my interest. And the longer I do it, the more I earn.
If I invested £100 every month in stocks paying a 5% dividend yield, after 30 years, I could have £83,000. That’s a considerable figure, especially when I’m starting with nothing at all. So let’s explore how that works.
If I invested £1,200 in Lloyds — which is currently paying around 5% — after one year, I’d have £1,260. That sounds ok, but it’s not groundbreaking. The impressive bit comes when you reinvest that dividend year-on-year.
After 10 years of paying in and reinvesting my dividends — assuming the dividend yield remains constant at 5% — I’d have £15,500. And after 20 years, £41,000. It’s all about the duration of the investment.
After 30 years, I could start looking to use my £83,000 to help fund my life. A 5% yield on £83,000 would give me £4,150 a year — that’s a healthy sum of money.
It’s not guaranteed, of course, and I could lose money rather than making it. But it’s also worth remembering that the general trend of UK shares is upwards. In 1992 — 30 years ago — the FTSE 100 was roughly one third of the size it is now.
For the purpose of this calculation, it could be worth imagining the share price growth countering the impact on inflation — although I’d hope to see the share price grow faster than inflation.
Finding UK shares to buy
For me, now is a good time to start looking for UK shares to buy. Share prices are depressed and dividend yields are up. But when investing for the long run, I want stocks that have a good record of paying dividends and increasing them annually.
As a result, I’d look at companies like Lloyds, Direct Line and Hargreaves Lansdown — a firm that I’m backing to outperform in the coming years.
