Using money to earn more money is not exactly a new idea. But when it comes to earning a second income, many people fixate on the idea of taking on more working hours rather than exploring possible alternative ways to boost their earnings.
Buying dividend shares can be a lucrative way to generate some extra income without working for it – especially if someone is willing to take the long-term approach.
Here’s why thinking for the long term can help build wealth
That long-term approach can be powerful because of a concept known as compounding. Put simply, compounding means reinvesting dividends, so that over time they in turn earn dividends.
Compounding can be a powerful force multiplier when it comes to building wealth – and a second income stream. For example, imagine somebody compounds £20k at a rate of 8% annually. After 25 years, their portfolio should be worth close to £137k.
At an 8% dividend yield, a portfolio that size should generate a second income of around £10,958 a year.
Thinking about dividends in the right way
Is an 8% return realistic? After all, it is more than twice the current FTSE 100 yield.
Above, I talked about compounding at 8% a year. That compound annual return could come from share price gain as well as dividends. But share prices can move up or down – and dividends are never guaranteed to last at any business.
In my example, after 25 years, I was presuming an 8% yield from a portfolio diversified across multiple different shares. In today’s market I think that is achievable even sticking to blue-chip businesses.
One share to consider
One FTSE 100 share I think investors should consider for its second income generation potential is financial services firm Legal & General (LSE: LGEN). The firm’s focus on retirement-linked products strikes me as a smart strategic choice. The market for retirement savings and pensions is large, resilient, long-lasting and involves sizeable sums.
With its strong brand, large customer base and history stretching back centuries, Legal & General is well-placed to benefit from that market. It aims to grow its dividend per share each year. The share currently yields 8.4%.
What might stand in the way of future dividends? One risk I see is that the sale of a large US business could mean revenues and profits shrinking markedly.
From a long-term perspective though, I regard Legal & General as being worth investors’ consideration.
Getting on the income train
Such a plan may sound fine in theory. But only putting it into practice will move it from an idea that takes just seconds to grasp to a second income idea that has been grasped!
One useful first move would be choosing a vehicle for investing the £20k. For example, that might be a Stocks and Shares ISA, share-dealing account or trading app. Fees and costs can eat into dividend income, so it can pay to take some time to make a smart choice.
After that, that money could then be put to (hopefully) productive use in the stock market!
