Earning a second income through dividend investing is possible with some key ingredients, careful techniques, and a well-thought out plan.
Let me explain what I would do to bag an additional income stream to enjoy in my golden years.
The important stuff
In my eyes, there are four vital things I need to do to achieve my aim. Pick the best investment vehicle, diligent stock picking, investing regularly and be mindful of risks involved.
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For my investment vehicle, a Stocks & Shares ISA is a no-brainer. This is due to favourable tax implications on dividends received, as well as a £20K allowance per year.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Next, for me to garner the largest possible pot of money to draw down from, I need to own the best dividend stocks. In order for me to identify and buy these, I usually look for some crucial characteristics. These include industry position, financial health, record of payouts, and future outlook for the business and dividends. Diversification is also important to help mitigate risk.
Moving on, I’d want to ensure I invest regularly, to a plan, to maximise my money. For context, in the example I’ll share shortly, I start with an initial lump sum to kick things off, and then invest every month with money from my wages.
Finally, from a risk perspective, I need to remember that dividends are never guaranteed. Plus, all stocks come with individual risks that can hurt performance and returns. Furthermore, I’d aim for an ideal rate of return, but could bag less. In turn, this could hurt the pot I’d draw my additional income from when I’m ready.
Crunching numbers
Let’s say I had £20K to get the ball rolling. I’d invest that in my ISA and start buying shares. Next, I’d put £300 per month into my ISA and do this for 25 years to continue buying shares and bagging dividends.
After this period, I’d be left with £432,111, if I achieved my target level of return, which is 8%. I’d then draw down 6% annually, which equates to just over £25,000.
A stock I’d buy to earn dividends
If I was following this plan today, one stock I’d love to buy for dividends and growth is Rio Tinto (LSE: RIO).
It is one of the largest mining businesses around, and provides crucial commodities such as lithium, iron ore, and copper. These metals have a multitude of applications in technology, construction, and renewable energy. These sectors are also growing as the world population increases, and digitization continues. This could result in increased earnings and returns for years to come.
However, from a bearish view, economic turbulence can hurt demand for commodities, and dent performance returns. For example, recent issues in China have hurt Rio Tinto, but these cyclical risks are unavoidable in the commodities market.
From a fundamental view, the shares look good value for money to me on a forward price-to-earnings ratio of just over eight.
Taking a look at returns, a dividend yield of over 6% is hugely attractive. For context, the FTSE 100 average is closer to 3.5%.
