One of my favourites methods of earning a second income is by investing in dividend-paying shares.
After all, dividends are essentially a share of a company’s profits. Businesses work hard to earn profits by using their knowledge, intellectual property and skills.
Many companies operate business models that are difficult to replicate. And I certainly wouldn’t be able to reach their scale myself.
So, the next best thing for me is to own a small part of a company and reap the rewards without lifting a finger.
Risks come with rewards
Bear in mind that rewards often require risk. Investing in shares isn’t risk-free. Companies can face challenges such as competition, new regulation or changing customer habits.
That said, one way I try to mitigate many of these risks is by owning a diversified group of stocks. By buying those from different industries, I aim to avoid putting all my eggs in one basket.
For instance, the risks that face a beverages company like Diageo are likely to be different to challenges faced by a pharmaceutical giant like Astrazeneca.
Building a five-figure income
I’m aiming to build a chunky second income from UK dividend shares. But I know that it won’t come immediately. After all, it takes time to make money.
But I don’t need to wait decades to reach this goal either. Assuming an 8% dividend yield, I calculate that I’d need a pot worth around £150,000 to earn an annual £11,737 of passive income.
I also calculate that I could build this pot by investing my full Stocks and Shares ISA allowance of £20,000 annually for just six years.
Bear in mind that if I have less to save every year, then I’d need to extend my timeframe.
It’s also worth noting that a relatively small proportion of UK dividend shares offer a yield of 8% or more. But those that do certainly stand out from the crowd.
For instance, Phoenix Group and Jupiter Fund Management both currently yield a whopping 11%.
But some that undershoot 8% still offer hefty payouts. Mining giant Rio Tinto and online trading platform IG Group both offer around 7% a year.
Questions to answer
There’s more to dividend shares than just the yield though. I’d also consider a few other factors that demonstrate their reliability.
As dividends are typically paid from earnings, I reckon it’s important to consider what’s likely to happen with a company’s profits over the coming years.
Are earnings likely to grow or at least remain stable? Can the business afford to continue paying its anticipated level of dividends?
These are questions that I’d look to answer when searching for the best dividend shares.
Overall though, I’d look for a selection of five to 10 top picks that offer strong brands, stable profits and a considerable dividend history. And once I’ve found a suitable bunch, I’d uses sources like The Motley Fool to monitor them to ensure they continue to meet my criteria.
