Hard work can often generate income. But does it need to be one’s own work? The answer is no. One way millions of people generate extra income is by investing in dividend shares to try and benefit from the labours of employees at some highly successful companies.
Here is how I would do that right now if I wanted to target £5,000 in extra income each year.
Spreading my choices
It can be tempting to look at a share with a very high yield — such as Diversified Energy with its 15.8% — and fantasise about how seemingly easy it might be to generate lots of income investing in it.
Sometimes such an approach works. But frequently, a company with an unusually high yield cuts its dividend.
In fact, no dividends are ever guaranteed. So, no matter how much I like a company (and I did own Diversified at one point in the past) I always, well, diversify across a range of companies.
Rather than looking to earn £5,000 in extra income from a single holding, I would aim to generate it from a diversified portfolio. I think investing in five different companies would give me sufficient diversification.
Income shares
To choose those five shares, I would hunt for proven companies that had a competitive advantage in a market with many customers. Cash generation is important as cash is what funds dividends.
Looking at today’s market, I would buy more shares of two stocks I already own. British American Tobacco owns premium brands like Lucky Strike. That gives it pricing power, which could help it offset the risk of long-term declines in cigarette volumes. It yields 7.6%.
I would also buy more shares in asset manager M&G. With a strong brand and millions of customers in over two dozen markets, I think the financial services powerhouse could provide extra income over the long term. It yields 9.9%. Market turbulence could lead to investors pulling funds, hurting profits. But longer term I expect resilient demand in the sector.
Legal & General would also make my shopping list. Choppy markets are again a risk to profitability, but the company benefits from deep experience and an iconic brand. It yields 7.7%.
I would also buy into Henderson Far East Income and the Income & Growth venture capital trust. They yield 9.2% and 10.9% respectively.
They offer me exposure to businesses in areas I think have strong long-term prospects, whether among large companies in Asia or startups closer to home. Returns from the funds’ investments can move around, impacting the dividends they pay to their own shareholders in turn. But as a long-term investor, I think the bigger story in both cases is attractive.
Building an extra income
Those five shares offer me an average yield of 9.1%.
So, to hit my target of £5,000 in annual extra income by splitting my money evenly across all five, I would need to invest just under £55,000. If I did that today, hopefully I could earn thousands of pounds in dividends annually for decades to come.
