Earnings often fluctuate over the course of a career – and sometimes dry up altogether. That is why the idea of a second income is attractive to lots of people.
Such an income can be even more attractive if it does not require extra work!
That may sound like a pipe dream. But one practical way millions of people including myself generate passive income is by investing in blue-chip dividend shares.
If I had an £80,000 nest egg I wanted to put to work today to target a £7,000 annual second income year after year, here is how I would go about it.
Taking the long-term view
I am a long-term investor. That approach can work well when it comes to building second income streams. Businesses with a unique competitive advantage in a resilient industry can often see their profits grow over the long term, enabling them to raise their dividends.
Indeed, firms such as Diageo and Sprirax-Sarco have raised their shareholder payouts annually for decades.
That does not necessarily mean they will keep doing so in future. Dividends can never be guaranteed, after all.
But if I carefully choose businesses with great characteristics and then spread my £80,000 over a few different ones, I hope at least some of them will not only keep paying out but indeed raising their dividends.
The concept of yield
Finding a great business in which to invest is only part of what makes for successful investment. The price you pay is also important.
When it comes to dividends, price helps determine dividend yield. If I pay £1 for a share and it pays 9p per share in dividends annually, my yield will be 9%. If I pay £3 for the same share, my yield would be only 3%.
To hit my target of a £7,000 second income annually, I would need to achieve a yield of around 8.8% on my £80,000.
At the moment, quite a few FTSE 100 shares offer such a yield, including Legal & General and M&G. I own both shares in my portfolio. But I did not buy them just because of their yield. First and foremost, I aim to buy into great businesses at attractive prices.
A high yield alone cannot tempt me to invest in a business. Indeed, a common trap is investing in mediocre businesses with high yields, only for the dividend to be cut.
Getting started
If I had £80,000 right now, I could put it in a share-dealing account and get going. Indeed, with the yields currently on offer at some blue-chip companies, I think I could invest the money soon.
But what if I don’t have £80,000 to spare? In that case, I would take the same approach but build up to my target over time, as funds allowed. Even if I do not earn £7,000 each year, a small but growing second income would still be welcome!
