More money but no extra work? That may sound too good to be true. But there is more than one way to earn a second income. For example, one method I use is building a portfolio of shares that I hope will pay me dividends in future.
Here is how I could do that, using an ISA with £20,000 in it (although the same approach could work with less money — I would simply earn less).
Getting ready to invest
To start, I would set up my Stocks and Shares ISA and put cash in it before the annual contribution deadline early next month. That way, I would have it ready to invest when I decided what shares to buy as I try to build a second income.
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But just because I had put the money into my ISA does not mean that I would rush to invest it. If I had already decided what shares to buy, I might start purchasing them immediately. But if I was still choosing, or the price of shares I liked was not yet attractive to me, I would patiently wait before putting the money to work.
Buying dividend shares
What sort of shares would I be looking for?
My second income would be made up of dividends. So I would want to invest in businesses I felt could make profits for years or decades to come, which they could pay out as dividends.
First I would look for areas I expected to experience high customer demand over the long term. I would then seek to identify firms operating in those areas I felt had some competitive advantage.
For example, Google parent Alphabet has what I see as a strong competitive advantage in an area I expect to see strong demand for a long time. Its shares are also trading at what I see as an attractive valuation.
But there is a final criterion I would use: is the company likely to pay out profits as dividends?
Alphabet does not, for example, as it keeps profits inside the business to fund growth. By contrast, I get juicy dividends from shares I own in mature industries. British American Tobacco is an example.
Building a second income
How much I might earn from this approach depends on several factors.
One is the average yield of the shares I buy. If I put £20,000 into shares with an average yield of 10%, my annual second income should be £2,000. If the yield was 5%, I ought to earn £1,000 each year in dividend income.
A company could stop paying dividends (or worse, go bankrupt) so I would spread my ISA investment over a diversified range of shares. Hopefully that could mean that investing £20,000 today would let me earn a second income for decades to come.
If I chose the right companies with great businesses, they may grow their profits and dividends over time. In that way, I may see my annual dividend income increase.
