Earning extra income without working for it sounds good to me. It sounds even better if the money keeps coming year after year.
I try to achieve that goal by investing in a portfolio of dividend shares. If I choose well, hopefully over time the dividends may grow – and could keep coming until I sell the shares. It might not happen, of course, as dividends are never guaranteed. But if I invest in a diversified group of high-quality companies, I do think it is a realistic goal to aim for.
Here is how I would build such a second income from scratch, with a weekly £50.
Building capital to invest
Putting aside £50 each week adds up to an annual sum of £2,600 I could use to buy shares. Dividends from those shares will hopefully form my extra income.
I currently plan to put any spare cash I have into my Stocks and Shares ISA before the annual contribution deadline next week. But even if I had no capital to start with, putting aside a steady £50 each week through thick and thin would mean that I soon had a four-figure sum in my ISA I could use it to start buying dividend shares.
Choosing shares
Many investors buy shares for the prospect of their price rising, because the business improves or simply because it is currently undervalued.
But with extra income as my goal, I would not focus on the potential for share price increases. Instead, I would ask myself a few questions to assess the suitability of a given share for my approach.
One is whether the business offers potential for large future dividends. Does it have a business model that could generate big profits, but the freedom to pay them out as dividends rather than use them to pay down debt, for example?
I would also look at the share price. While share price growth may not be my objective, I still do not want to overpay. The amount of extra income I could earn depends on the average dividend yield of my portfolio and that is partly a reflection of the price I pay for the shares.
Risk also needs to be considered. I would assess the risks of shares before buying them and also once I already owned them. For example, I recently sold my Vodafone shares. Although I find the company’s 8.6% yield is attractive, I see its heavy debt as a risk to profitability. To reduce risk, I also keep my portfolio diversified across a range of different stocks.
Building an extra income
Putting £2,600 into shares with an average 8.6% yield (like Vodafone) would hopefully earn me around £224 in dividends annually. That is a high yield for a FTSE 100 company, though, so I would likely expect my portfolio to yield something closer to 5% or 6% overall in today’s market.
Investing £2,600 at an average yield of 6% ought to earn me £156 in dividends per year. If I kept saving £50 per week to invest, over time I would hopefully build my portfolio – and the extra income it generated for me.
