From bills to treats, a bit more money could often come in handy. One way I try to earn some extra income is by drip-feeding money into shares I hope will pay me dividends in future.
That lets me benefit from the commercial prowess of some of the country’s largest businesses. I also like the fact that I can invest at my own pace and do not need a big upfront sum.
Here is how I would aim to build such a portfolio from zero, to target £800 each month on average in dividend income.
How dividends work
The theory underpinning this approach is quite straightforward. Using the money I save, I can buy a share in a company. That is effectively a tiny stake in a firm listed on the stock market, like Shell or Tesco.
Sometimes, a company pays out some or all of its profits to shareholders in the form of a dividend. For as long as I hold its shares, I will receive any dividends a company pays.
Shell has a dividend yield of 3.6%. So for every £100 I put into Shell shares now, hopefully I will receive £3.60 in annual dividends.
Future uncertainty
However, that might not happen. Challenging business conditions could lead Shell to cut its dividend, as it did in 2020 (and Tesco in 2014). Then again, perhaps the opposite will happen and a company will increase its dividends.
I try to manage this uncertainty in several ways. One is diversifying across a range of shares. Another one – that is central to my approach as a long-term investor – is focussing on what I see as high-quality businesses trading at an attractive price.
Finding shares to buy
I do not think it is difficult to find great businesses. But it can be tricky to find them at an attractive price.
For example, I think instrument maker Judges Scientific is a solid business. It has a track record of strong annual dividend increases. But other investors like Judges too, so it trades on a price-to-earnings ratio 59, with a yield of just 0.8%.
That level of yield will not help me build my extra income streams very quickly.
Building a portfolio
So as well as hunting for shares in great businesses selling at attractive prices, I also look for a strong yield.
This can be a gradual process. Putting money aside each week does not mean I need to invest it immediately. I can patiently wait for high-quality shares to trade at what I see as an attractive price.
Building extra income streams
Doing that over time, my dividends will hopefully add up. If I can achieve an average dividend yield of 5%, then saving £100 each week should mean I hit my target of £800 in monthly extra income after 37 years.
I would hopefully start earning income in year one and keep on doing so every year. It may take decades to get to my target, but I can earn dividends along the way as I go.
