Dividend stocks can be an excellent method of producing a second income. In fact, it’s probably one of my favourite ways.
There’s much to like about these investments. For instance, they offer regular income. Like clockwork, every quarter, I’d receive regular cash inflows in the form of dividends. And over time, I’d also expect the underlying value of my stocks to rise.
These are ultimately businesses that I’m investing in. And the dividends they send to me are a share of the profits.
There are three steps to successful dividend investing, in my opinion.
Eggs in multiple baskets
First, I’d diversify my portfolio. There are great risks to just buying one or two stocks. If a crisis hit one of my companies, it would have a significant impact on my total pot.
And protecting the investment pot is key. After all, investors need money to make money.
To avoid putting all my eggs in one basket, I’d look for a selection of stocks. I’d also want to spread my money across several industries to reduce my risk further.
Thinking ahead pays dividends
Next, I’d need a long-term mindset. Although I receive dividends regularly, the bigger money is made if I can stay invested for many years.
Instead of taking out the dividend income every quarter, I’d reinvest it by buying more shares. Then next year, I’d earn dividends on these new shares as well as on my original investment.
This process is an effect called compounding, and it should result in amplified returns.
The table below demonstrates what I mean.
It’s quite feasibly to find a basket of stocks that offer a 7% dividend yield. I’d say several of the biggest and best ones reside in the FTSE 100.
If I invested £3,000 in these, I’d expect to earn around £210 a year in dividends. Not bad, but also not enough to be considered a second income, in my opinion. But if I can invest this sum every year, I’d expect the results to be significantly better.
Note how dividend income really ramps up in the latter years. By continuing this process for 30 years, I’d expect to earn almost £20,000 a year in dividends. This would certainly make a useful lifetime passive income.
| Years | Total Value | Dividend income |
| 5 | £17,252 | £1,207 |
| 10 | £41,449 | £2,901 |
| 20 | £122,986 | £8,609 |
| 30 | £283,382 | £19,836 |
Finding the best dividend stocks
Finally, I’d need to pick some suitable dividend stocks. A high yield doesn’t necessarily mean it’s a good stock. In fact, it may only be temporary. Instead, I’d look for consistent, growing dividends. This might indicate that the company is profitable and stable.
As dividends are typically paid from earnings, I’d want my companies to demonstrate strong financial health, and a solid business model.
Right now, I consider the following to be good UK dividend stocks that meet my criteria: Phoenix Group, Legal & General, NatWest Group, Schroders, and Imperial Brands.
This selection of five currently offers a 7% dividend yield. And if I had spare funds to start a new dividend investment plan today, I’d buy all five today.
