Work, work, work does not always equal pay, pay, pay. But even when it does, there is a limit on how much work most of us can or want to do. That is why if I wanted to build a second income I would try to achieve it by investing in dividend shares.
Here is an example of how I could adopt such an approach in the coming decade to target an extra £10,000 a year in income.
Dividend shares
When companies make a profit, they have to decide what to do with it. Some may pay down debt or reinvest it in the business. But others will divvy it up with shareholders, by paying them what is known as a dividend.
I own shares in FTSE 100 companies such as British American Tobacco and M&G that pay me dividends. These are never guaranteed. But they can be substantial. Indeed, a regular stream of dividends form the basis of my plan to generate a second income.
To get going, I will need to decide what shares to buy – but I also need money to invest. Rather than doing that all at once, I could contribute a regular amount over time and build up my investment funds.
For example, imagine I achieve an average annual dividend yield of 5% on my portfolio. By putting in £1,300 each month and compounding the dividends, after a decade I ought to have a portfolio worth just over £200,000, earning me a yearly £10,000 second income.
Doing the maths
The above example presumes constant share prices and dividend yields but, in reality, both could move around. Dividends can go down, although they can also increase. Indeed, I mentioned above that I own British American Tobacco and its dividend has grown annually for over two decades.
That £1,300 invested might sound like a lot of money to outlay each month. But if necessary, I could change the amount to match my own financial circumstances. But that would impact the annual income target I could hit after 10 years.
Going for quality
Why have I used 5% as an example yield? After all, some shares offer more, in some cases quite a bit more. Over time, well-run companies may increase their payout too. That could mean the yield based on my initial purchase price will be higher.
I think a 5% average yield is possible in the current market while sticking to high-quality, blue-chip shares. But I would not start by looking at a share’s current yield. After all, no dividend is ever guaranteed.
Instead, I focus on searching for great businesses I think have some competitive advantage they can translate into profits over the long term. If I find them, I then consider their dividend prospects. By identifying such shares and building a diversified portfolio of them, I could hopefully build a sizeable second income over the next decade.
