I can think of dozens of ways to earn a second income. But my favourite method right now would be to own a basket of quality dividend shares.
There are several components in that sentence so let’s break it down. Dividend shares typically distribute payments to shareholders every quarter. This is a share of a company’s profits.
I’d consider some to be much higher quality than others though. So in my own portfolio, I prefer to stick with those that demonstrate quality characteristics. This can include profitability, consistent earnings and low levels of debt.
Next, I wouldn’t just want to own just one or two stocks. Companies can be hit with unexpected challenges at times. That’s why I prefer to diversify. A carefully selected basket of shares can spread risk so I’d avoid putting all my eggs in one basket.
Overall, that’s why I’d buy a basket of quality dividend shares rather than simply a couple of them.
Targeting a second income
To aim for almost £10,000 a year of additional income, I’d have to calculate what size of pot I’d need to begin with.
If I can earn an 8% yield on this dividend portfolio, I calculate that I’d need a pot worth £117,325 to reach my goal.
If I didn’t have this sum to start, I could still reach my goal but only if I postpone the date I start withdrawing funds.
I calculate that by investing £20,000 in a Stocks and Shares ISA every year for just five years, I’d expect to build a pot large enough to reach my targeted second income.
How I’d earn 8% a year
For this strategy, I’d focus on FTSE 100 shares. This large-cap index includes dozens of quality dividend shares, so there’s little need for me to look anywhere else.
But the average dividend yield in the Footsie is just 3.7%. That means I’d need to dig a little deeper to find my preferred shares.
What I’d buy today
For instance, I see that Phoenix Group offers a whopping 9.7% yield. Normally, I’d be wary of yields that look particularly large. They’re often unsustainable.
But in this case, I don’t believe this is the case. It earns more than enough in earnings to comfortably cover dividend payouts. I also like that it has grown its dividends consistently over the past seven years.
Next on my list is Rio Tinto. This global iron ore miner is a powerhouse in supplying material for steel. Presenting a return on capital employed of 25%, I’d consider it a quality share. This relatively mature business offers a dividend yield of 6.2%.
Building a basket
Note that as I’m targeting an 8% yield for my basket of shares, not all the individual stock picks need to meet this threshold.
Other shares that I’d buy today include Legal & General, Imperial Brands and Barratt Developments. By owning all five of these dividend shares, I’d expect to earn an average yield of 8%.
Bear in mind that I’d need to keep an eye on my shares as much can change over the years. I also have to accept that I might not achieve 8% and I could even lose money, That said, I reckon this is a solid selection to target my second income plans.
