How I’d turn a handful of dividend stocks into a lifelong second income!

We all love passive income. Here, Dr James Fox explains how dividend stocks can help portfolio growth and second income generation.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Young black colleagues high-fiving each other at work

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

If I had £1,000 in dividend stocks, the most I could realistically generate in passive income is £80 a year. And that’s an exceptional yield. Under normal circumstances, it would be almost impossible to find stocks offering yields around 8%.

However, £80 a year isn’t going to be life-changing. And I believe this is what puts many Britons off investing. They’re aware that with limited capital, they’ll struggle to generate any noteworthy returns in the near future.

That’s not the case, however, when we take a long-term approach to investing. Because with compound returns and regular contributions, we can turn a handful of dividend stocks into a lifelong second income.

Getting started

If I were new to investing, I’d want to make use of the Stocks & Shares ISA. This is an excellent vehicle for creating passive income because all returns generated within the ISA wrapper are tax free.

The process of opening a Stocks and Shares ISA varies, depending on the provider. However, I can open a Stocks and Shares ISA account with most major investment platforms. My preference is Hargreaves Lansdown — by far the UK’s largest brokerage — but investors with limited capital may prefer platforms with lower fees.

Opening an account can typically be done quickly, usually within 15 minutes. Although a deposit is often needed to start a basic account these days, it’s possible to begin with very little initial funding.

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.

Goals and affordability

Moving forward, the next step involves defining my objectives and gaining a clear understanding of what’s feasible within my financial capacity. Naturally, if I have lofty passive income goals, I’m going to need more than just £1,000 in dividend stocks.

Thus, the necessity arises to formulate a systematic savings strategy, preferably on a monthly basis, which will serve as the means to cultivate and expand my portfolio over the course of time.

This methodical approach should not only align with my aspirations but also underscores the importance of discipline in the pursuit of long-term financial growth.

Compound returns

When investing for the long run, I need to harness the power of compound returns. This is a reinvestment strategy that leads to exponential growth. It’s incredibly simple and is often misunderstood by novice investors.

In essence, compound returns involve not just earning from the initial investment, but also from the accumulated interest or profits, leading to exponential growth over time.

Of course, this works regardless of the figures involved. So, in practice, if I had £1,000 invested in stocks returning 8% a year — it doesn’t matter if the returns come in the form of share price gains or dividends — I’d be reinvesting my returns every year while adding a contribution, say £200, every month.

Here’s a very crude illustration of how a portfolio could grow assuming at 8% annualised return. I’ve also included a 5% increase in the size of the contribution to keep up with inflation.

Created at

I have to note that while I could achieve better than 8% annualised returns, I could also do worse. I need to make wise investment choices, and this means doing my homework.

Finally, the second income. It all depends on when I want to withdraw. After 20 years, this plan could yield £13,000 a year. After 30 years, it could yield £38,000. And after 40 years? It could yield £100,000!

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

2024 year number handwritten on a sandy beach at sunrise
Investing Articles

Here’s my plan to make the most of juicy UK shares ahead of 2024 and beyond!

Our writer reckons there hasn't been a better time to snap up quality UK shares. She explains how she's planning…

Read more »

Young Black woman using a debit card at an ATM to withdraw money
Investing Articles

Here’s how many Lloyds shares I’d need to buy for a £100 monthly income!

Offering a higher dividend yield than the average across FTSE 100 stocks, are Lloyds shares worth buying for passive income…

Read more »

Playful senior couple in aprons dancing and smiling while preparing healthy dinner at home
Investing Articles

Up 27% in 2023, what next for the Tesco share price in 2024?

The Tesco share price has had a great 2023, rising 27% while the FTSE 100 was flat. But what might…

Read more »

Hand is turning a dice and changes the direction of an arrow symbolizing that the value of an ETF (Exchange Traded Fund) is going up (or vice versa)
Investing Articles

FTSE 250? No, I’d buy this index fund instead

Investing in index funds can be a profitable enterprise. Our author has been exploring the different options to determine the…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

This 4% yielding FTSE 100 giant is dirt-cheap and perfect for passive income!

Looking for a mammoth business with shares trading at discount levels and offering an excellent passive income opportunity? Our writer…

Read more »

UK money in a Jar on a background
Investing Articles

Here’s how I’d use dividend shares to try and turn £5,000 of savings into passive income of £900 a year

With dividend shares at today’s prices, Stephen Wright thinks there are two ways to turn a £5,000 investment into something…

Read more »

Investing Articles

After a recovery that Lazarus would have been proud of, is the easyJet share price worth a look?

With its dividend restored and its balance sheet repaired, the easyJet share price looks like a bargain. But Stephen Wright…

Read more »

Photo of a man going through financial problems
Investing Articles

Are Rolls-Royce shares REALLY about to pay a dividend?

Rolls-Royce shares are expected to start paying dividends in the near future. But how realistic are the company's current forecasts?

Read more »