Owning assets can be a great way of earning a second income. And dividend stocks are among the best assets to own for earning passive income.
With interest rates rising, share prices have been coming down. As a result, building a portfolio that pays out £10,000 per year is easier today than it has been for some time.
Dividend stocks
There are FTSE 100 stocks with big dividend yields at the moment. So the amount I’d need to invest today to earn a £10,000 second income might not seem that high.
British American Tobacco shares, for example, have a dividend yield of 9%. As a result, an investor could generate £10,000 per year in dividends from a £111,111 investment.
The trouble is, a high yield can be a sign that investors think a company’s dividend payments are relatively risky going forward. And a lot of the time, they’re right.
British Tobacco has some impressive unit economics. But it is going to have to contend with a decline in the number of smokers in the areas where it generates most of its revenues.
Investing well involves finding opportunities where the market is too pessimistic. With dividends, this means a high yield that will prove more durable than investors think.
Stocks to buy
Right now, I think there are some good opportunities for investors. And one of the best, in my view, is Lloyds Banking Group (LSE:LLOY).
Since the start of the year, shares in Lloyds have fallen by around 9%. With rising interest rates pressuring the company’s loan book, this is understandable.
But there’s a lot for investors to be positive about. In its most recent report, the bank announced wider margins and a 25% increase in profits from the previous year.
Management also increased margin guidance for the rest of 2023 and the ratio of loans to deposits remained stable. So I think the degree of market pessimism is unjustified.
Investors should be wary of charges for bad loans, which came in at £419m. But a 6% dividend yield looks attractive to me, even given the risk of further expenses.
Stocks and Shares ISA
At today’s prices, I’d need to invest £166,666 into Lloyds shares to earn £10,000 in dividend income. But there’s one more complication for investors to consider.
In the UK, basic rate taxpayers are taxed at 8.75% on dividend income over £1,000. And this is set to increase next year to include anything over £500.
So if I earned £10,000 in dividends from Lloyds shares, I’d pay away £787 in taxes. Fortunately, investments held in a Stocks and Shares ISA are exempt from dividend tax.
Investors like me can buy up to £20,000 in shares each year in an ISA. So I’d have to build up to the amount I’d need for a £10,000 second income over a number of years.
As a result, I’d start building a second income with Lloyds shares today. And, I’d look to diversify my portfolio with other investments when opportunities present themselves.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
