One of my preferred ways to earn a second income is by owning dividend shares. Having some money hit my account every quarter is a particularly nice feeling.
But there are a few things to consider when thinking about how to invest for regular income.
If I was investing £20,000 for this purpose, my first port of call would be to open a Stocks and Shares ISA. This would ensure I don’t need to pay any dividend or capital gains taxes.
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. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Chunky yields
Next, I’d look to create a basket of high-quality dividend shares. As I’m looking to earn income as soon as 2024, I’d focus on stocks that offer above-average dividend yields.
Right now, the average FTSE 100 dividend yield is around 3.8%. But for my basket of shares, I’d aim to earn 6% to 9%.
Bear in mind that double-digit yields might not be sustainable. If earnings struggle, companies could cut or suspend payments at any time.
Today, it’s encouraging to note that almost 20% of the FTSE 100 offers a yield in excess of 6%. That makes this large-cap index an excellent place to search for income stocks, in my opinion.
Searching for a second income
When it comes to earning a second income from shares, there’s more to it than just the dividend yield though. As payouts are typically paid from earnings, it’s important that investors consider business basics.
For instance, I’d look at how sustainable earnings are likely to be, and if the business owns strong brands that are likely to withstand the test of time.
Dividend cover is a useful measure to calculate how affordable a company’s payment is. It looks at how many times a dividend can be paid from current earnings. Typically, I’d look for a figure of at least 1.2.
Next, I’d prefer to own shares that have a long and consistent history of making payments. It doesn’t guarantee future payouts, but a long period of reliability can offer a degree of comfort.
How I’d implement this strategy
Once I’ve narrowed down my options, I’d build a diversified group of shares to own for my ISA. By that, I mean that I’d buy shares that span a variety of industries. Also, I reckon five to 10 stocks should sufficiently spread my risk and avoid putting all my eggs in one basket.
Right now, if I had £20,000 to put toward a second income strategy, I’d split it equally across the following shares: Phoenix Group, Imperial Brands, Rio Tinto, Land Securities, Sainsbury (J), BP, and Barclays.
On average, this selection offers a 7% yield, a dividend cover of two and a whopping 25-year history of back-to-back payments.
By the end of the first year, it should result in dividend income of £1,400. If it doesn’t sound like much, keep in mind that investing is about consistency and a long-term mindset.
So far we’ve looked at a one-off £20,000 investment. But if I can add this sum to my ISA every year for just five years, I calculate that I’d earn a second income of £8,000 a year.
As factors can change over time, bear in mind that I’d still need to monitor my selection. But overall, it sounds great to me.
