The idea of earning some extra money on a regular basis without working for it may sound too good to be true. But while I find the idea of a second income attractive, I think there can be a less labour-intensive way to earn it than taking on another job. Investing in shares.
That is the approach I am currently taking.
While my second income may be very modest for the first few years, the good news is that this approach does not take a lot of money upfront and can be funded for just a few pounds a day. Here is an example of how I could aim to start generating dividend income by investing £5 a day.
Dividends and income generation
When a successful company makes money, it has a choice about what to do with it. It can retain the cash in the business to help fund growth. But a common alternative is to pay at least some of it out to shareholders in the form of dividends.
That means if I buy shares in such a company, I ought to receive dividends for as long as it pays them and I own the shares.
To illustrate this, consider Vodafone as an example. At the moment, its dividend yield is 8.6%. That means that if I spend £100 on its shares today, I will hopefully earn £8.60 in dividends over the coming year. Not only that, but I should earn that amount every year I hold the shares, although I only need to pay for them once.
If Vodafone raises its dividend, I could earn more. But the reverse is also true. If the dividend is reduced or cancelled, my earnings from the shares will fall. Vodafone has cut its dividend before and I see a risk it will do so again, as it has a large debt pile to service.
Building a dividend portfolio
Still, an 8.6% yield is juicy – especially if it is maintained. All shares carry risks, not just Vodafone.
That helps explain why I always diversify my portfolio across a range of shares. But while that may reduce the impact on my second income of any one company cutting its dividend, it does not mean I am willing to accept risks from a given share that exceed my personal tolerance.
So instead of looking first at the yield of a share, I start by trying to find great businesses I think are selling below their fair value.
If a company has promising prospects for long-term profitability, for example due to patented technology that is set to stay in high demand, then I will consider whether its share price and yield might help it merit a place in my portfolio.
Growing a second income
Although £5 a day may sound like a small sum to invest, it can soon add up. In a year, putting aside that amount on a daily basis would give me £1,825 to invest. If I used that to buy shares in blue-chip companies with an average yield of 5%, I would set up a second income of around £90 per year.
If I kept saving and investing hopefully, over time, that ought to grow.
