No matter how hard one works, there are only so many hours in the day. That is not about to change! That helps explain why many people aim to build a second income by doing something other than taking on an additional job.
My own approach is to build a portfolio of shares that pay me dividends that I can then invest in buying more shares. Over time, I reckon that can help me build a substantial additional income stream.
I do not need any money to begin, as I can put a regular saving programme in place and use that to start buying shares.
As an example, here is how I could target a £20,000 annual second income by investing £300 each month.
Getting into the habit
I do not have to go for £300 each month. The same approach could work with £1,000 each month or £50. Although the speed at which I hit my target would change accordingly, the basic principles apply no matter how much I invest.
I would invest a regular amount based on what suits my own financial circumstances. I would put the money into a share-dealing account or Stocks and Shares ISA. By doing so on a regular basis, hopefully I could get into an investment habit that may last for decades and help me build wealth.
Buying dividend shares
Simply having money in an investment account is not going to generate the second income I am aiming for. Instead, I would invest it in shares I think can pay me dividends in future.
In doing so, I would follow four key rules.
Four investment rules
First, I would only invest in businesses I understand. That is important because it gives me the ability to assess the prospects for the companies in which I invest.
Secondly, I would only buy shares I thought had the potential to pay sizeable dividends for a long time to come. Past performance does not necessarily indicate what will happen next. So I look for businesses with a competitive advantage in an area in which I expect to see long-term customer demand, such as Unilever or National Grid.
Thirdly, like any investor I might get things wrong. A company can be blindsided by some unforeseen event, leading to it cancelling dividends. So I always diversify across a range of companies.
And I pay attention to the price I pay for shares. If I overpay, then even if I earn juicy dividends, I could end up losing money from my investment.
Hitting my second income target
Taking that approach, I could hopefully start to earn dividends.
Rather than using them as extra income immediately, I would reinvest them so they could start earning dividends themselves. That is known as compounding and could help me reach my target faster.
If I can earn an overall average compound growth rate on my whole portfolio of 5%, investing £300 each month should earn me a £20,000 annual dividend income after 39 years.
That may sound like a long time to wait. But I could also decide not to compound and simply take the dividends as cash when they are paid. That way, hopefully, I would grow my second income in coming years.
