Dividend stocks continue to be among the most popular investment vehicles in the UK. After all, who doesn’t love getting paid for doing nothing more than owning shares in a portfolio?
The FTSE 350 is home to a wide range of income-generating enterprises spanning multiple industries and geographies. That makes it a perfect hunting ground when looking to build up a diversified portfolio. And for those fortunate enough to have £20,000 in savings, snapping up these shares today could lock in a £30,000 annual second income in the long run. Here’s how.
The magic of compounding
Earning interest on interest, in the long run, creates an impressive snowball effect that can turn a modest sum into a ginormous pile of money. So much so that it could even turn £20,000 worth of savings into a five-figure second salary.
However, the key words here are ‘long run’. Pulling off this financial feat won’t happen overnight, but we can estimate the timeline with a few extra details. The FTSE 350 has historically provided investors with a total average annualised return of 9%, with dividend yields sitting around 4%.
By being a bit more selective, pushing this yield to 5% without taking on excessive risk shouldn’t be too much trouble. And assuming the capital gains remain consistent, that pushes the theoretical return to 10% a year.
If I’m targeting £30,000 in passive income at a 5% yield, I’d need to build a portfolio worth around £600,000! That’s 30 times more than my starting capital of £20,000, and it’s hugely unlikely I’m going to find this sort of money stuffed down the couch cushions.
Yet compounding my savings at 10% can get me there in just over 34 years. Obviously, that’s a long time to be waiting around. But if I were to supplement my savings with an extra £250 each month, I could cut almost 10 years from this timeline.
Risk and reward
There’s no denying the prospect of earning an extra £30k a year is exciting. For some, it might even be sufficient to stop working full-time and have more free time with family and friends. But like everything in investing, nothing is ever guaranteed.
A custom-built portfolio has the potential to outperform a benchmark index such as the FTSE 350. This means this wealth-building journey could be completed even faster. Sadly, the opposite is also true. Suppose I were to pick the wrong stocks? In that case, my returns could fall behind, and I may even venture into negative territory.
Furthermore, dividends themselves can become compromised. Even the healthiest enterprises today could start to crack should they start to fall behind competitors. And as we’ve all been reminded, external threats such as a global pandemic or economic instability can wreak havoc on even the biggest businesses in the world.
All of this is to say that investors may end up with significantly less than expected. However, even with these risks, investing in high-quality enterprises for the long run continues to be one of the best ways to build wealth. At least, that’s what experience has taught me.
