I reckon investing in dividend-paying stocks is a great way to build a second income.
Let me break down how I’d approach this.
Steps I’d follow
A Stocks and Shares ISA is the perfect investment vehicle for me as I’d pay less tax on dividends. Plus, with a generous £20K annual allowance, I can invest up to this limit each year.
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Stock picking is next. Personally, I find it’s important to look for quality over quantity, as well as consistency of payouts over high yields. I need to also factor in valuation, past track record of performance and returns, and future prospects.
Finally, I need to decide how often and how long I’m investing, as well as how much. I want to invest for a longer period to maximise my pot of money, in order to enjoy a larger second income later in life.
Let’s say I had £10,000 to hand today. I’d use this as an initial investment. Next, I’d look to add £250 per month from my wages too. As I’m a long-term investor, I’d look to follow this plan for 25 years.
I’d look to achieve an 8% rate of return for my money. Based on the amounts, rate, and time mentioned, I’d be left with £237,830. For me to then enjoy this as a second income, I’d draw down 6% annually, which equals £14,269.
This is just one example of how I’d approach bagging a second income. However, I could invest differing amounts or initial amounts depending on circumstances changing.
It is worth mentioning that dividends are never guaranteed. This could impact the 8% rate of return I’m aiming for. If I achieve less, my pot will decrease.
Example stock
If I were following this plan, I’d love to buy Supermarket Income REIT (LSE: SUPR) shares for a few key reasons.
Firstly, being set up as a real estate investment trust (REIT) means that Supermarket Income must return 90% of profits to shareholders.
Next, as it provides property for supermarkets, growth and defensive traits help me believe that the returns will keep flowing. The UK population is growing, and supermarkets need more floor space than ever to cater for the changing face of shopping, including warehousing and e-commerce. From a defensive standpoint, everyone needs to eat, no matter the economic outlook.
Moving on, the shares offer a dividend yield of 8%, which is the target I’ve mentioned above. Plus, the shares look cheap as they trade on a 16% discount to its net asset values (NAVs).
Finally, it already has fantastic relationships with established supermarkets such as Aldi, Asda, Tesco, Sainsburys, and more. It could leverage these into growing earnings and returns.
From a bearish view, higher interest rates do concern me. This is because REITs like Supermarket use debt to fund growth. At times like now, higher rates mean debt is costlier to obtain and service, which could hurt earnings, and eventually returns.
