Earning a second income does not necessarily mean giving up glorious summer evenings to work a second job. One simple alternative is to build a portfolio of shares in blue-chip companies that look likely to pay their shareholders dividends.
Dividends are one way a company can choose to use its spare cash (or some of it). They are never guaranteed, so it is important to choose the shares carefully when investing with a second income as the goal.
The amount of second income a certain sum of money might generate this way can be estimated using what is known as a dividend yield. That is the annual amount of dividends expected as a percentage of the price paid for the shares. So for example, to earn a £1k second income each year from a £20k sum, an average yield of 5% is required.
This is higher than the current average FTSE 100 yield of 3.4%. But I think 5% is achievable. Plenty of FTSE 100 shares currently yield this or higher.
Setting up a practical way to invest
The theory of buying dividend shares is fine, but a practical way to do it is required. So a useful first step would be to set up a share-dealing account, Stocks and Shares ISA or trading app to place the £20k.
Building a portfolio of income shares
I mentioned that dividends are never guaranteed. Even a company that had paid out regularly in the past can cut or cancel its dividend without notice. So it makes sense to be careful when choosing what shares to buy. A simple additional risk management technique is to diversify the funds across different shares. Twenty grand is ample for that.
One share I think investors should consider for its second-income-building potential is British American Tobacco (LSE: BATS). It currently yields 6.6%. The company behind cigarette brands including Lucky Strike is a proven cash generator on a large scale. Making cigarettes at scale is cheap and they can be sold at high prices.
That simple yet powerful business model helps explain why British American is able to generate sizeable cash flows. Those have enabled it to grow the dividend per share annually for decades. Not that this is guaranteed to continue, of course.
A soaring share price in the past year
With fewer people smoking cigarettes, volumes are falling. British American can mitigate this by raising selling prices but, over time, there is still a clear risk that profit could decline and the dividend may be cut.
Up 49% over the past year, the British American tobacco share price seems to be shrugging off such a risk for now.
The market is not always right. But British American Tobacco has been dealing with weakening demand for decades — and is still pumping out huge dividends every quarter.
