The idea of earning more money without having to work for it certainly piques my interest. People try to earn a second income in different ways. My own approach is to piggyback on the success of blue-chip companies by buying dividend shares.
If I wanted to do that in the coming year with the aim of generating £250 each month on average in passive income, here is how I would go about it.
Earning money from dividend shares
At one level, the idea of investing in dividend shares seems simple enough. Dozens of blue-chip FTSE 100 companies have proven they know how to make money and divvy it up among shareholders in the form of dividends.
However, the reality is not necessarily that simple. For one thing, dividends are never guaranteed. Even a company has maintained its annual dividend for many decades, it can suddenly cut it. Shell did just that in 2020.
Also, dividends are only one element in the possible return from a share. Another is capital gain – or loss. If I invested in a share that paid me dividends but plummeted in price, I could end up losing money.
So when looking at shares to buy with the objective of generating a second income, I always consider not only their dividend prospects but also their valuation.
Finding shares to buy
That said, I do think there are some attractively valued FTSE 100 shares that offer compelling dividend prospects.
For example, this year I have bought blue-chip shares such as British American Tobacco and Legal & General. Both offer a yield over 8%, meaning that for every £100 I invest I will hopefully earn £8 in annual dividends.
Not only that, but I like the prospects of such companies relative to their price. Indeed, that is a key reason why I bought them.
That said, even a brilliant company can run into unforeseen difficulties. That explains why I always diversify my portfolio across a range of companies and different industries.
Aiming for a target income
Yield is useful in calculating how much I ought to invest to try and hit a certain income.
For example, if I wanted to earn an average monthly second income of £250, that would give me £3,000 a year. If my portfolio yielded an average 10%, I could achieve that by investing £30,000.
Ten percent is unusually high for a yield, although some FTSE 100 shares like British American Tobacco and Vodafone do offer just such a yield.
If my average yield was half that – 5% – I would need to invest £60,000 to hit my target second income in 2024
If I did not have that sort of cash lying around though, I could start from zero and drip feed money into a Stocks and Shares ISA. How long it took me to hit my target would be influenced by my saving rate.
