If I’m looking to build a second income, I’d much prefer it to be passive. After all, there are only so many hours in the day, which limits how much time (and energy) I can devote to the hard graft of a second job.
Enticingly, the internet today promises various ways of generating passive income, including blogging and dropshipping.
But how passive are these ventures?
Time-consuming second jobs
Blogging, for example, will need new and engaging content to keep eyeballs returning to my site. Most blogs I come across these days haven’t been updated in months (sometimes years).
Admittedly, dropshipping does sound attractive, in theory. I can sell products I’ve never touched, from countries I’m not in, to consumers I’ve never met. But it takes a lot of hard work to build up a successful dropshipping brand.
Therefore, while they might prove lucrative, these sound more like second jobs to me, and time-consuming ones at that.
Earning money as I sleep
However, when I invest in dividend shares, the income I hope to receive is truly passive. As a shareholder, I’m entitled to a slice of the cash flows generated by the real-world companies behind my stocks.
To give an example, the last dividend I received was on 24 November from Greencoat UK Wind. This is an investment company that owns both offshore and onshore wind farms across the UK.
Normally, I’m pretty on the ball when it comes to payment dates. But this one caught me by surprise as I woke up to the pleasant notification on my phone. I’d been paid an interim dividend by a 6%-yielding stock while I was asleep.
It was the textbook definition of passive income!
ISA investing
Better still, that payment was tax-free because it was in my Stocks and Shares ISA account. And this is the key part of my strategy. I’m going to try to use the full contribution limit available to me as a UK-based investor.
Currently, this means I can put in £20,000 a year (the equivalent of about £384 a week) while not having to worry about any tax obligations.
To me, this makes the Stocks and Shares ISA a no-brainer.
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.
Top-notch dividend stocks
Within my ISA, I’m going to continue targeting high-quality stocks with above-average dividend yields.
High-quality means the companies have strong market positions and resilient cash flows to afford to regularly pay dividends. And I personally want stocks with great track records of rising payments stretching back years. As with my porridge, I’m not after lumpiness.
Of course, no individual dividend is ever truly guaranteed. Conflicts, severe recessions and even pandemics do happen, after all. But by filtering out companies that don’t match my criteria, I reckon I’m giving myself the best chance of success.
In general, my target dividend yield range is 5.5%-9%. That range is comfortably above the FTSE 100 average yield, which is currently around 3.9%. And it’s above the risk-free amount I can secure in most savings accounts. That said, it does involve more risk than traditional savings.
Harnessing compound interest
Someone’s sitting in the shade today because someone planted a tree a long time ago
Warren Buffett
Finally, I’m playing the long game to maximise my durable passive income. That means I’ll be reinvesting my cash dividends over 10 years instead of spending them.
This will mean I harness the supercharging power of compound interest.
For example, if I secured an annualised 9% return, I’d end up with £303,858 after a decade. From this, I could hope to receive around £27,347 a year in tax-free passive income, again with that 9% yield.
This is why I invest regularly in dividend shares.
