Millions of Britons are thinking about how they could earn a second income. It’s not just me.
Investors have become more conscious that they need to get their money working. With inflation reaching double figures last year, it makes sense.
I always argue that I don’t need to be investing purely in dividend stocks today if I want to generate a passive income in 20 years’ time.
Personally, I invest in a mixture of growth-oriented stocks and dividend-paying stocks to advance my own wealth. After all, it’s worth remembering that the growth stocks of today could be the big dividend stocks of the 2040s.
What I’d buy
There are three ways I like to break this down. Firstly, a good proportion of my investments are growth-focused. These are the companies that drive my portfolio.
My investments in stocks such as AppLovin, Celestica, Nvidia, Powell Industries, and Abercrombie & Fitch have all grown by around 100% over the past 12 months alone.
However, growth-focused investments often carry more risk. Thankfully, my success rate has been high, but I have a couple of underperforming investments. From being up around 35% in February, I’m now down 35% on the Chinese EV maker Li Auto. It’s very volatile.
The second part of this portfolio mix is investing in growing dividends. This can mean choosing companies with a track record of increasing their dividend payments, or just companies we think will prosper over the long run.
It’s worth remembering that the dividend yield’s always relative to the price we paid for the stock.
For instance, if an investor picked up Lloyds‘ (LSE:LLOY) stock 20 months ago with a 5.75% dividend yield, they’d currently be receiving close to 7.5% annually as the dividend payments have increased.
And finally, there are the big dividend payers like Legal & General and Phoenix Group. These stocks don’t tend to offer much in the way of share price growth, but these 8%+ dividend yields can compound nicely.
How much could I make?
Focusing in on Lloyds, my forecasts have the share price growing by roughly 5% annually over the medium term. Meanwhile, the dividend yield currently sits around 5% — there’s room for growth here with a dividend coverage ratio of 2.75.
And while Lloyds shares have surged in recent months, it’s worth recognising that the stock still trades with a considerable discount to its international peers — namely those in the US.
Investors are still cautious about the UK economy. Brexit, the interest rate environment, and a stagnant economy still weigh on the share price and represent near-term risks.
As a cyclical investment with 68% of loans being UK mortgages, Lloyds isn’t the stock for investors who don’t believe in a brighter future for Britain. However, the forecasts for the UK economy and Lloyds are pretty strong.
Using some fairly conservative estimates, I believe a £10,000 investment in Lloyds today could compound at 10% annually — share price gains and dividends.
In turn, this would give me £6,946 annually as a second income in 20 years.
Despite this, my preference is to spread my money evenly among investments. Diversification helps mitigate risk.
