One way to earn a second income is to build a portfolio of blue-chip shares that pay out dividends.
How much an investor needs to invest to meet a particular target depends on a few things. One is the prospective dividend yield at the time of investing. Another is whether that prospective yield ends up being delivered. After all, no dividend is ever guaranteed.
Understanding the role of dividend yield
Let’s start with yield.
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At a 10% yield, a £5,000 annual second income would require investing £50,000. At a 7.5% yield, it would take £75,000. At a 5% yield, the amount required rises to £100,000.
So, does it make sense just to invest in 10% yielders, such as FTSE 100 insurer Phoenix (LSE: PHNX)?
Maybe – but maybe not.
Just investing on the basis of yield alone is a mug’s game. Dividends can be cut or cancelled — so the prospective yield today can end up being very different to the actual yield in future.
That said, I could be interested if a good company selling at an attractive share price also offers a high yield. I do not invest just because of yield. But equally, I would not be put off just by a high yield.
In fact, it could make the share more attractive for me when it comes to building a second income.
Quality first and foremost
Phoenix is a case in point, as it is a share I think investors should consider.
The company operates in a large, complex market. That complexity acts as a barrier to entry, although there are still plenty of rivals in the insurance market.
But Phoenix has a number of advantages. One is its large customer base, numbering around 12m. Another is its collection of trusted brands, including Standard Life and SunLife. It also has a proven business model that has helped underpin annual dividend growth in recent years, a feat the firm aims to replicate in coming years.
No share is risk-free and a double-digit yield does make me wonder if I have missed something other investors see as a big risk.
One concern I have is the impact any property market downturn could have on the valuation assumptions used in Phoenix’s mortgage book. If those assumptions need to be revised, that could be bad news for profits.
Spreading the risk
Overall, though, I see a lot to like about the investment case for Phoenix.
But things can change, so no matter how much I like a share I always keep my portfolio diversified. With the average FTSE 100 yield currently hovering around 3.6%, a 10%+ yield is exceptional. A 7.5% average yield, however, is less exceptional.
I think I could aim for a £5k annual second income investing £75k in the current market. I am not doing that all at once, but bearing in mind annual ISA allowances, am building up to it over time.
