Snapping up a few income shares of dividend-paying companies is all it takes to start generating some effortless money in the financial markets. But with most stocks only offering a few pence per share, how much does an investor need to buy to start generating a meaningful second income?
Targeting a monthly amount
Companies choose when to pay dividends and can change the timing at their own discretion. Therefore, it’s more appropriate to set income goals on a yearly basis rather than monthly. So for those seeking an extra half-grand each month, the annual dividend generation target for a portfolio is £6,000.
Now let’s introduce the concept of yield. This percentage metric reveals how much a stock will generate in returns from dividends based on the initial price paid. For example, a stock priced at 100p, which pays a dividend of 4p per share, has a yield of 4%.
Assuming all the positions within my income portfolio add up to a weighted average yield of 4%, then to hit my £6,000 passive income threshold, I’d need a portfolio worth roughly £150,000. Needless to say, this isn’t pocket change. But hitting this level of wealth is far more achievable than most might think.
Building a six-figure portfolio
It’s important to remember that earning £500 a month is the destination, not the starting point. And by investing small sums of capital consistently into top-notch income shares, it’s possible to build up to this target over time. This journey can even be accelerated by reinvesting any dividends received along the way, as well as aiming for a higher yield.
For example, a carefully constructed income portfolio could realistically produce a 5% yield without taking on excessive risk. And in this scenario, I’d only need a £120,000 nest egg.
The FTSE 100 is filled with plenty of income-paying businesses, a good chunk of which are mature industry leaders. And even if an investor only manages to match the index’s 8% average total annual gain, that’s more than enough.
To demonstrate, at this rate of return, investing just £500 a month would boost my portfolio to £120,000 within 12 years and £150,000 within 14. At this point, I could stop reinvesting dividends and start watching the money roll in.
Investing has its risks
As easy as this sounds, there are some caveats to consider. Most important is the fact that the stock market doesn’t always go up. The correction in 2022 quickly reminded investors that valuations can have significant pullbacks, even among some of the best businesses in the world. Consequently, investors could be waiting far longer than anticipated to hit their desired income goals.
It’s also important to note that dividends are not guaranteed. These payments serve as a mechanism for businesses to return excess earnings to shareholders (the owners). But if earnings become compromised, dividends can quickly follow, resulting in cuts, or even outright cancellations, compromising my income stream.
The good news is these threats can be partially mitigated by deploying risk management strategies like diversification. And while risk can never be completely eliminated, the potential gains that investing offers make it an endeavour worth pursuing, in my mind.
