There are only so many hours in the day. Like a lot of people, I do not want to spend most of them working. But boosting my earnings with a second income still sounds attractive to me.
Here is how I would aim to do that by spending £250 each month to build a portfolio of dividend-paying shares.
Dividends to boost my income
Let me first explain what dividend shares are. Take British American Tobacco (LSE: BATS) as an example.
Making cigarettes is quite cheap, but tobacco’s addictiveness alongside premium branding can mean they sell at a juicy profit margin.
Last year, British American sold £27.7bn worth of cigarettes and other products like nicotine pouches. It had to pay various costs of doing business, like paying for materials, staff costs, taxes and £1.6bn in interest charges. But after all such deductions, the firm still earned £6.8bn in post-tax profits. That is a 25% net profit margin.
It used around 65% of those profits to fund dividends. Those are paid four times a year, and should amount to £2.31 per share this year. So if I buy one share, I ought to earn £2.31. If I buy 100, I should receive £231. And if I buy 1,000, I will hopefully get £2,310. That could help me build my second income.
Long-term outlook
In fact, I would hopefully keep earning dividends year after year. They might even increase, as British American Tobacco has raised its shareholder payout annually for decades.
But dividends are never guaranteed. As that hefty interest bill suggests, the firm has a lot of debt. Servicing that could reduce the money available for distribution to shareholders. Cigarette sales are in long-term structural decline, which could eat into both revenues and profits at the firm.
Part of the way I manage such risks is by diversifying my portfolio across a range of companies. I try to stick to businesses I think have a working model that could be profitable long into the future.
Doing the maths
Hopefully that can help me build up extra income over time.
Sticking to high-quality businesses with attractive share prices means I do not just chase high yields. Ultimately though, how much dividend income I will hopefully earn depends on the amount I invest and the average yield of the share portfolio I build.
Consider an average yield of 5% for example (meaning each year I earn £5 in dividends for every £100 I have spent on the shares). I would need to invest £480,000 to hit my target of £2,000 per month, on average, in dividends. Saving £250 each month, that would take me 160 years!
I would try to speed things up by reinvesting the dividends (known as compounding). Doing that, presuming a steady 5% annual return, I could hit my income target of £2,000 each month in 45 years.
That is still a long way off though. If I can earn higher yields while still owning quality shares, that could help me earn more sooner. British American yields 7.1%, compared to the 5% I presumed in my example above.
It is not easy to find brilliant shares with great dividend yields. But doing so could help me as I aim to build lifelong additional income.
