One of my favourite ways to earn a second income is by owning dividend shares. By executing a clear strategy I’d expect to earn regular and reliable dividend payments, typically every quarter.
With bank savings rates of 5% why should I bother with owning shares though? Especially when the average FTSE 100 dividend yield is around 3.8%. First, note that some of the best dividend shares often yield more than 7%.
Granted, the gap between current dividend yields and bank savings rates has narrowed in the last year or so. That said, I’d still pick dividend shares. Here’s why.
Why dividend shares?
As inflation has risen, I want my investments and income to at least keep pace with rising prices. And I reckon many shares will be able to meet this criteria.
Investing in companies is about more than just receiving dividends every year. Many businesses aim to grow earnings over time too. This can often result in a larger overall business.
Some companies also aim to grow annual dividends consistently over time. Those that have managed to do so over many years are often referred to as dividend aristocrats.
Bear in mind that dividends aren’t guaranteed. Management can decide to cut or suspend payments at any time. That said, I’d aim to mitigate this risk by owning a basket of quality dividend shares.
Earning that extra income
So how could I earn a second income of around £4,000 a year? Even with the best dividend shares in the UK it would be near impossible to achieve this goal with a £10,000 Stocks and Shares ISA.
That said, if I were able to add £10,000 a year to my ISA for just five years I calculate that I’d potentially own a pot worth almost £58,000. And with a dividend yield of 7% that should be more than enough to reach my goal.
Owning quality businesses
Although dividend shares are often seen as less risky than the higher-octane growth stocks, investment gains still aren’t guaranteed.
One way to mitigate some of the risks is to own high-quality businesses. By this, I’m referring to companies that offer an array of quality characteristics that include earnings growth, high return on capital invested, and chunky profit margins.
These businesses might operate a long-standing dividend policy that’s unlikely to change soon. One way to quantify this is to look at its history. For instance, some of my favourite income stocks have been distributing dividends to shareholders for decades.
Shares to buy
If I was building a new ISA from scratch, I’d buy NatWest Group, Barratt Developments, ITV, IG Group, and Rio Tinto.
On average, this small selection offers a 7% dividend yield. They also operate in different sectors. Spreading risk across sectors should help me to avoid putting all my eggs in one basket.
And given their profitability and potential for growth, I’d describe this basket as a quality dividend portfolio.
