Investing in high-quality dividend shares is widely considered to be one of the best ways to earn passive income.
It requires relatively little effort and can result in a consistent income stream that can grow over time.
However, aiming for a substantial second income from dividend stocks will require me to implement a disciplined investment strategy. Not to mention exercising a bucket load of patience.
Targeting a sizeable passive income
Assuming I could achieve an average yield of 8%, I’d need a portfolio worth around £625,000 to earn £50,000 a year in dividend income.
If I was starting from scratch without any savings, then by investing £500 each month into a basket of diversified stocks, I could reach a portfolio worth almost £650,000 after 29 years (assuming an annual return of 8%).
Now that wouldn’t be straightforward. After all, there’s no guarantee I could achieve an average return of 8% over an extended period of time.
Nevertheless, embracing a long-term mindset will help me ride out market volatility and benefit from the power of compound returns.
In any case, the FTSE 100 average return has historically trended between 6% and 8% over the long term, so it’s something for me to aim for.
Achieving an 8% average yield
To achieve a good enough average yield on my portfolio, I’d focus on high-quality income stocks with a history of strong dividend growth.
I’ll also need to target stocks with relatively high yields that are known for their generous dividend payouts.
That said, I’ll be cautious of yields that appear excessive as they can sometimes indicate financial distress.
The companies offering high yields that I’m looking at must be fundamentally sound. They’ll also not be at major risk of cutting dividends.
This means targeting companies with strong dividend coverage (where a firm’s earnings are sufficient to support its dividend payments).
Top UK dividend shares
Considering the above, companies such as British American Tobacco, Legal & General, Phoenix Group, and Rio Tinto make it to the top of my watchlist.
Company | Dividend yield |
British American Tobacco | 8.4% |
Legal & General | 9% |
Phoenix Group | 9.9% |
Rio Tinto | 8.2% |
Each one benefits from strong cash flows and has a history of stable and consistent dividend payments.
Furthermore, there’s ample diversification. Legal & General and Phoenix Group operate in the financial services sector, Rio Tinto is involved in mining, and British American Tobacco is the in consumer goods industry.
Crucially, investing equally in these stocks would enable me to achieve an average yield of around 8.8%, taking me one step closer in my pursuit to earn £50,000 in yearly passive income.
Be that as it may, I’m aware that dividends are never guaranteed. And the pandemic serves as a recent example of this unpredictability.
Many companies, even historically reliable dividend payers, faced financial challenges as revenues declined and uncertainty gripped the markets.
In an effort to conserve cash and strengthen their balance sheets, numerous firms suspended or reduced their dividend payments. This is something for me to always bear in mind moving forward.