How much do I need to invest in dividend stocks to earn a £10,000 second income?

With the FTSE 100 yielding around 3.5%, investors need £285,714 to earn a £10,000 second income. But Stephen Wright thinks it’s possible to do better.

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Investing in dividend shares can be a great way of earning a second income. Participating in the success of exceptional businesses can be extremely lucrative. 

WIth interest rates set to fall, higher share prices have been causing dividend yields to fall. So how much would I need to invest to earn £10,000 per year in passive income from the stock market?

Dividend yield

The short answer is that it comes down to what sort of return I think I could get from a portfolio of dividend stocks. At the moment, the FTSE 100 has an average dividend yield of 3.5%. 

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At that level, I’d need a portfolio worth £285,714 to earn £10,000 per year. That’s assuming I invest in a Stocks and Shares ISA to avoid having to pay tax on my dividends.

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.

That’s a lot, but I think it might be possible to do better by focusing on some of the highest-quality stocks in the index. Bunzl (LSE:BNZL) is a good example. 

The stock currently has a dividend yield of around 2%. That hardly stands out as a passive income opportunity, but it has an impressive growth record that I think it’s worth paying attention to.

Growth

Over the last decade, Bunzl has gone from paying out 33p per share in dividends to 64p. And it just boosted its interim dividend by a full 10%. 

If that continues for another 10 years, the dividend the company pays out to investors in 2034 will amount to a 4.7% return on the cash they invest today. That makes the equation look quite different.

At that level, I could earn a £10,000 second income by investing £212,765. And if the dividend increased by another 5% for 10 more years, the amount would come down to £130,208.

Of course, the Bunzl share price might well go up as its dividends increase. But I think there could be an opportunity to invest today for some great returns over the long term as the business grows.

Risks

Of course, the risk with this strategy is that the business might not grow as anticipated. If that happens, the dividend is unlikely to increase as quickly and I might end up with less income than I’d hope.

Bunzl is a company that generates growth by acquiring other businesses. And the danger is that it either pays too much for an acquisition or runs out of targets to add to its network. 

Those are risks that investors should take seriously, but it’s worth noting that management is alive to this possibility. And I think it has been very careful in how it deploys its capital.

Where the company hasn’t been able to find acquisition opportunities, it has returned cash to investors through share buybacks. And that should give shareholders some confidence going forward.

Doing more with less

If I just invested in the FTSE 100 as a whole, I’d need around £285,714 to earn a £10,000 second income. But I think it’s possible for investors with time on their side to do better.

Companies that can grow their dividends in the future can provide serious passive income. Even if the starting yield is low, it can turn into something quite substantial.

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Bunzl Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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