Imagine if you wanted to start building a second income but did not want to work more. What would you do?
For me, one obvious approach would be to invest in income shares. Those are shares that could pay me dividends.
If I had a spare £5,000, I could start doing this today and target an initial annual income of £400. Here is how I would go about it.
Some basic principles to start investing
I would begin by putting my £5,000 into a share-dealing account or Stocks and Shares ISA so I had a vehicle to invest.
An important principle when investing is to reduce the risk of an unfortunate choice by diversifying across a range of shares. With £5,000, I could do this comfortably. I would split the money evenly over five businesses.
As income as my focus, I would not be too concerned about finding companies with strong growth prospects. Instead, I would look for blue-chip companies with businesses I understand that have a proven commercial model. They do not need to be consistently profitable, but my bias would be for firms that have demonstrated an ability to be profitable most years.
As dividends are never guaranteed and past performance is not necessarily a guide to what will happen next, I would not obsess about a company’s dividend yield when trying to build my second income.
Instead, I would study its business and finances to decide whether I felt it looked likely to generate enough profit and free cash flow to pay dividends for years to come.
Five shares I’d buy today
Using those principles, I would put my money into the five companies below.
British American Tobacco has an addictive product and premium brands, giving it pricing power. A decline in cigarette use could hurt profits, however.
Legal & General is a financial services powerhouse that benefits from a strong brand and large customer base. But volatile markets could lead some customers to withdraw funds, hurting profits.
Vodafone has a large telecoms business in Europe and Africa, benefitting from a huge customer base and its extensive network. The high cost of maintaining that network could eat into profits, though.
M&G is a well-known asset manager with operations in over two dozen countries. Its customer base and experience attract me, though continued success partly relies on its fund managers doing well even in difficult markets.
Unilever has a yield of 3.7%, much lower than the other companies above. I also see a risk that a recession could lead to lower sales volumes, as consumers look for cheaper products. But its iconic brands and wide reach give it a big competitive advantage, in my view.
Income ahoy!
The above handful of shares have an average yield slightly above 8%.
That means that, investing £5,000 in them today could hopefully earn me an annual second income of £400.
The five offer me diversification, but all are members of the flagship FTSE 100 index of leading shares.
Dividends are never guaranteed. That said, four of the five raised theirs last year. The fifth (Vodafone) kept its steady and currently yields 9.7%.
