Here is a simpler-sounding idea to generate a second income than taking on an additional job: buying a portfolio of high-quality shares in the hope that they pay dividends.
Dividends are never guaranteed, so it pays to manage risks by diversifying the portfolio properly and carefully assessing shares before purchasing them. Still, this could be a simple and fairly lucrative scheme, depending on how much someone invests.
Cutting your coat according to your fabric
How big the second income might be depends on a few factors. In short, those are the size of investment, what the average dividend yield is, and how long someone waits.
Let’s examine each in turn.
Size of investment: suit yourself
Investing in the stock market is a flexible activity that can be tailored to an individual’s circumstances.
That might involve a lump sum, for example, or it could be regular investing. It might even be irregular investing, drip feeding spare money in as and when you have some.
Dividend yield: a helpful financial measure to understand
The second factor that determines the income is dividend yield. Basically that is the annual dividends earned, expressed as a percentage of the cost of the shares. For example, a 5% yield means for each £100 invested, the annual dividends will hopefully be £5.
Stockbroking costs can eat into the second income, so it pays to weigh different options when choosing a share-dealing account, Stocks and Shares ISA or trading app.
Time: the friend of the savvy investor
The third factor is time. For example, let’s stick with the 5% yield. That is well above the current FTSE 100 yield of 3.1%. Nonetheless, I think it is possible while sticking to blue-chip companies.
With a monthly second income target of £500 (£6k a year), a 5%-yielding portfolio would need to be worth £120k to hit the goal.
An alternative approach is initially reinvesting dividends before drawing the income. This is known as compounding. From nothing, someone investing £1k a month and compounding it at 5%, the portfolio would grow to £120k in under nine years.
Choosing income shares with long-term potential
When I look for a share (because I want to build income streams), I do not just look at its current yield. That is a snapshot of current performance and changing business performance could mean future dividends (if any) are different. So I look at how strong the business seems and what its future prospects may be.
For example, one dividend share I think investors should consider is City of London Investment Trust (LSE: CTY). By investing in a carefully selected group of leading British shares, the trust has been able to grow its dividend annually since the 1960s.
Over the past five years, there has also been good news in terms of share price performance. The 45% gain is below the 53% achieved by the FTSE 100 during that period. But I still see it as a strong result.
Sticking mostly to British blue-chips, the trust exposes itself to the risk that a weaker UK economy could hurt its performance. But it is also exposed to a well-established market where some companies sell at attractive valuations.
That could help provide long-term capital growth, as well as the prospect of juicy dividends.
