I’d build a second income using £5 a day

Christopher Ruane outlines how, for a fiver a day, he’d aim to build a growing second income by investing in well-known businesses.

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The idea of earning some extra money on a regular basis without working for it may sound too good to be true. But while I find the idea of a second income attractive, I think there can be a less labour-intensive way to earn it than taking on another job. Investing in shares.

That is the approach I am currently taking.

While my second income may be very modest for the first few years, the good news is that this approach does not take a lot of money upfront and can be funded for just a few pounds a day. Here is an example of how I could aim to start generating dividend income by investing £5 a day.

Dividends and income generation

When a successful company makes money, it has a choice about what to do with it. It can retain the cash in the business to help fund growth. But a common alternative is to pay at least some of it out to shareholders in the form of dividends.

That means if I buy shares in such a company, I ought to receive dividends for as long as it pays them and I own the shares.

To illustrate this, consider Vodafone as an example. At the moment, its dividend yield is 8.6%. That means that if I spend £100 on its shares today, I will hopefully earn £8.60 in dividends over the coming year. Not only that, but I should earn that amount every year I hold the shares, although I only need to pay for them once.

If Vodafone raises its dividend, I could earn more. But the reverse is also true. If the dividend is reduced or cancelled, my earnings from the shares will fall. Vodafone has cut its dividend before and I see a risk it will do so again, as it has a large debt pile to service.

Building a dividend portfolio

Still, an 8.6% yield is juicy – especially if it is maintained. All shares carry risks, not just Vodafone.

That helps explain why I always diversify my portfolio across a range of shares. But while that may reduce the impact on my second income of any one company cutting its dividend, it does not mean I am willing to accept risks from a given share that exceed my personal tolerance.

So instead of looking first at the yield of a share, I start by trying to find great businesses I think are selling below their fair value.

If a company has promising prospects for long-term profitability, for example due to patented technology that is set to stay in high demand, then I will consider whether its share price and yield might help it merit a place in my portfolio.

Growing a second income

Although £5 a day may sound like a small sum to invest, it can soon add up. In a year, putting aside that amount on a daily basis would give me £1,825 to invest. If I used that to buy shares in blue-chip companies with an average yield of 5%, I would set up a second income of around £90 per year.

If I kept saving and investing hopefully, over time, that ought to grow.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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