Building a second income does not have to mean working many more hours each week.
Take buying shares as an example. Some pay regular dividends to their shareholders. By putting money into such shares and initially reinvesting the dividends, I think I could build a sizeable second income.
Here’s how.
The saving bug
Putting aside money on a regular basis can seem difficult at first. But it can be habit-forming. Over time, hopefully I would get used to this disciplined approach and so miss the money less as it went out of my wallet.
Saving £300 a month would add up to £3,600 per year. How much second income could that generate?
That depends on the average dividend yield I earn. If it is 5%, £3,600 would earn me £180 in annual dividends. If it was 8%, that number would rise to £288.
Compounding
Still, either number is a long way off my annual target of £18,000.
If I kept saving, that would help. I would also reinvest my dividends to start with, something known as compounding.
Investing £300 a month at an 8% yield and compounding the dividends, after 23 years I would have a portfolio generating over £18,000 in dividends annually.
At that point, I could keep compounding. Or I could take the dividends I received each year in cash and start generating an £18,000 annual second income as per my plan.
Quality first
That example presumes a constant yield and share price for the shares in which I invest. In reality that is unlikely.
Dividends are never guaranteed and share prices tend to move around. I would try to mitigate against some risks by spreading my portfolio across a range of shares.
But could I also use the uncertain nature of dividends to my advantage?
I think so! Specifically, I would aim to invest in companies that I thought looked likely to keep growing their payout – and help set me up with a lifelong second income.
To do that, I would not focus on yield first. Instead, I would aim to find businesses with a competitive advantage in an industry I felt would benefit from robust long-term demand.
Examples I would consider for my portfolio — if they had an attractive valuation — include Unilever and Guinness brewer Diageo.
High-yield opportunities
But with a yield of 2.3%, Diageo is far from the 8% example I used above. My approach could still work buying such shares, but may take many decades.
So while I do not start my hunt for shares by focussing on yield, it would nonetheless be something I considered when deciding what to buy.
That involves buying great quality companies, but only when their shares are at an attractive price and with a good yield.
Finding such bargains can be difficult. So I would be patient and, rather than rushing to invest my monthly £300, be willing to wait for really great opportunities to come along.
