Earning a second income can mean working at one full-time job during the day, then spending valuable leisure time working at another one. There is a far less time-consuming approach to setting up additional income streams, however: investing in shares that pay dividends.
With the right approach and timeframe (this is not an overnight scheme, by a long stretch) such an approach can be very lucrative.
Showing the income potential of dividend shares
As an example, say someone has £20,000 of savings. If they invest that in shares that average a compound annual growth rate of 8% and keep it there for 40 years, at the end of the period, they ought to have a share portfolio throwing off a second income of around £34,579 per year.
Yes, 40 years is a fairly long time to wait for the income. But this is a long-term approach to investing.
The power of compounding dividends
What, then, is a compound annual growth rate?
Here, I imagine the investor compounding dividends (that means reinvesting them) and achieving an annual growth in the portfolio value of 8% annually.
That does not just have to be from dividend income: share price growth could also help. The reverse is true too, though: a decline in the value of shares owned could lower the compound annual growth rate.
Clearly, then, it is important to take time finding and choosing the right shares, as part of a diversified portfolio. £20k is ample to diversify across, say, five to 10 different shares.
One share to consider
In the current market – and the coming 40 years will most likely see both ups and downs – I think an 8% target is achievable.
In fact, some shares have a dividend yield (the annual dividend per share expressed as a percentage of the current share price) at that level now. Do remember, though, that share price movements also impact the compound annual growth rate.
One such share I think second income hunters should consider is FTSE 100 asset manager M&G (LSE: MNG).
At the moment, its dividend yield is 9.1%. M&G aims to maintain or raise its dividend per share each year.
But, as with any share, the dividend is never guaranteed to last. So — as always — an investor needs to weigh the pros and cons of the investment case as they see it. Different people have different risk levels and financial goals.
On the plus side of the ledger, I see M&G as a proven business in an industry that is both large and resilient. Its large customer base, brand, and deep experience should all help it.
Looking at some minuses, though, one risk I see is policy holders pulling more money out of M&G’s core business area than they put in. The firm has been battling with that problem lately and it poses a risk to future profits.
Making the right moves to start
As well as dividends and share price movements, total return can be affected by the costs and fees involved in investing the £20,000 through a share-dealing account, now and in the future.
So I think a simple but powerful first move for a second income hunter is to compare different share-dealing accounts, trading apps, and Stocks and Shares ISAs to see what works best for them.
