The idea of earning a second income by owning dividend shares is not new or radical – but it can be financially lucrative.
If someone wanted to target an average £1,000 monthly second income buying dividend shares, here are three possible approaches they could take.
Approach 1: invest in a top index tracker fund
£1,000 a month adds up to £12k in a year. At the moment, the FTSE 100 index of leading companies yields around 3.4%. So to hit that target immediately, someone could invest around £353k into a FTSE 100 tracker fund.
Most people do not have a spare £353k and even if they did, they may prefer not to invest it all at once, but instead utilise their annual allowance over time in a Stocks and Shares ISA.
This approach does have some possible advantages though. The second income could start flowing within months and it would be generated by a broad-based basket of blue-chip businesses.
A range of index trackers is on offer. It would make sense to compare them, as they may charge in different ways for monthly income withdrawals.
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.
Approach 2: drip feed money into blue-chip shares
Another approach is to start from zero and invest an affordable amount monthly into an ISA or share-dealing account.
No dividend is ever guaranteed, but I see value in sticking to blue-chip shares with proven businesses. Rather than just tracking the FTSE 100 though, an investor could buy a diversified portfolio of selected individual shares. Doing that, I think it is possible to target a 7% yield in the current market.
One share investors could consider is British American Tobacco (LSE: BATS). The owner of brands including Lucky Strike has a highly cash generative business that helps fund a big dividend. The dividend per share has grown annually for decades and the current yield is 7.4%.
British American has a strong brand portfolio, proven business model and large customer base. However, I do see risks. Cigarette sales are declining in many markets, eating into revenues and profits. Non-cigarette products like vapes may replace some of those sales volumes. But that remains to be seen — and how profitable they will be over the long run.
Still, the cigarette market remains substantial and I expect it will be around for a good while yet. British American has proven able to generate lots of excess cash and willing to divvy it up among shareholders.
If an investor put £500 a month into blue-chip shares yielding an average 7%, their second income hopefully ought to grow annually and within 29 years they should be earning £1k each month.
Approach 3: unleash the financial power of compounding dividends
That 29-year wait to hit the target could be cut to just 16 years using the same approach — with one difference. Rather than taking out the dividends along the way, an investor putting in the same £500 each month at an average 7% yield could initially reinvest the dividends.
Then, once the portfolio was big enough (after 16 years), they could start receiving the dividends as a second income. This approach is known as compounding – and is a simple way to try and grow a sizeable second income from dividend shares faster.
