I’d invest £500 a month to target a £45,000 second income from dividend shares

Regularly investing money in the stock market can build a substantial portfolio capable of generating passive income through dividend shares.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Diverse group of friends cheering sport at bar together

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Even though the recent stock market rally has pumped up the valuations of leading dividend shares, there are still plenty of UK income stocks trading at good prices. Building a diversified portfolio of high-quality businesses today could lead to a surprisingly large nest egg for a more comfortable retirement.

In fact, drip-feeding just £500 a month into the stock market could produce a seven-figure portfolio generating £45,000 in annual passive income. Here’s how.

Finding high-quality dividend shares

As previously mentioned, not every dividend-paying stock has recovered from the 2022 correction. And for investors brave enough to buy these discounted shares even with all the economic uncertainty, greater wealth can potentially be unlocked in the long run.

Should you invest £1,000 in Manchester United Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if Manchester United Plc made the list?

See the 6 stocks

However, it’s essential to avoid falling into classic income traps. While the adverse macroeconomic environment is already improving, its short-term effects might have permanently damaged certain businesses. Even the firms whose operational cash flows have already recovered may be in trouble if their balance sheets are riddled with debt.

After all, rising interest rates make servicing loan obligations more expensive, with fewer financial resources left over to fund payouts from dividend shares. But for the companies still in robust shape, these short-term disruptions may soon be over, paving the way for prosperity as overleveraged rival firms struggle to get back on their feet.

Turning £500 into £45,000

Looking at the FTSE 100, the average dividend yield among the largest listed enterprises in the UK currently stands at roughly 3.5%. Therefore, to generate £45,000 from 3.5%, an investor will need a portfolio worth just over £1.28m.

Needless to say, that’s not exactly loose change. But as crazy as it may seem, consistently investing £500 each month can establish a nest egg of this size in the long run. To accelerate the process, investors can turn to a more growth-focused index such as the FTSE 250.

Historically it has produced average annualised returns of 10.6%. And investing £500 a month at this rate would theoretically result in a portfolio worth £1.29m in just under 30 years. This could potentially unlock an earlier retirement for individuals in the early years of their careers.

When the threshold is hit, investors can reallocate their capital to the FTSE 100 index and reap an annual 3.5% yield. Alternatively, they could choose to pick individual dividend shares to increase their passive income stream. Even if the portfolio yield grows to just 4%, that’s an extra £6,200 a year.

Nothing is risk-free

As exciting as the prospect of earning nearly double the average UK salary in passive income is, it’s important to remember that the stock market can be volatile.

There’s no guarantee that indexes’ past performance or dividend yields will continue for the next three decades. Moreover, crashes and corrections occasionally rear their ugly heads, disrupting the wealth-building process. And depending on the timing of these events, an investor may end up with considerably less than expected.

Nevertheless, the potential rewards of dividend shares make these risks worth taking, in my opinion.

Of course, there are plenty of other passive income opportunities to explore. And these may be even more lucrative:

We think earning passive income has never been easier

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

My favourite UK stock is up 365% in 5 years and analysts still say it’s a strong buy!

Harvey Jones loves this top UK stock but was wondering whether it would finally run out of steam. Its response…

Read more »

Investing Articles

Is the stock market going to crash when the tariff window expires?

The stock market’s rallied on news of a 90-day pause to some US tariffs. But could it be set to…

Read more »

Investing Articles

2 investment trusts to help investors become Stocks & Shares ISA millionaires

One of the biggest challenges for new Stocks and Shares ISA investors is which investments to make. Dr James Fox…

Read more »

Investing Articles

The Greggs share price has plummeted for good reason! It’s now a proper dividend stock

Dr James Fox explores whether the beaten-down Greggs share price represents a potential buying opportunity or a value trap.

Read more »

Working from home due to social distancing
Investing Articles

A year ago, £10,000 in Tesco shares — at today’s price — is now worth…

Tesco's provided solid investor returns since April 2024 thanks to strong share price gains and healthy dividends. Can it keep…

Read more »

Investing Articles

Just released: our 3 top small-cap stocks to consider buying in April [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »

Investing Articles

Here’s why Tesla stock just rocketed 22.7%! Is it time to buy?

This writer wonders whether the news that sent Tesla stock soaring yesterday is a true gamechanger for the electric vehicle…

Read more »

Investing Articles

2 quality UK stocks to consider buying as share prices rally

With UK stocks moving higher, it might look as though investors with cash on hand have missed their chance. But…

Read more »