A second income does not always mean taking a second job. For example, by investing in shares, millions of people regularly earn dividend income. That may be pennies in some cases – but with the right approach, it can be substantial.
Here is an example of how I could aim to turn a £20,000 Stocks and Shares ISA into a moneymaking machine earning me an average monthly second income of £500.
The basic principle
If I invest in dividend shares, the amount I will hopefully earn each year depends on two factors – the size of my ISA and the average dividend yield I earn from my portfolio.
Starting with £20,000, it may seem that the amount I invest is fixed. For example, at an average yield of 4%, I would earn £800 annually in dividends. If I could push my average yield up to 7%, I would be looking at £1,400 each year in dividends.
But even if I only invest £20,000 into my ISA, I might end up having a lot more than that available for me to invest. If I reinvest the dividends I earn rather than taking them as cash (something known as compounding), I can start to build the size of my ISA and essentially earn dividends on my dividends.
Taken from a long-term perspective, that can have a huge impact.
If I compounded dividends of 8% annually, after 18 years my average second income from dividends would already have topped £500 each month. Not only that, but having invested £20,000 of my own money 18 years earlier, I would hopefully keep earning that second income for the rest of my life… without investing another penny in my ISA.
In practice, that happening would depend on whether the shares I owned maintained their dividends. That is never guaranteed. The payouts could be cut. On the other hand, they might increase over time.
Investing in winners
In fact, that is exactly what I would aim for when investing. If I buy into great businesses with strong growth prospects, I think it is realistic to hope that they may increase their dividends (and my second income) over time.
Every share has risks, so I would diversify my portfolio across multiple shares. But the characteristics I would look for in each share would remain the same.
I try to find proven businesses in areas I expect to experience strong customer demand. In each case, I hunt for a source of long-term value that can set the business apart from competitors. That could be owning an iconic brand like Coca-Cola, patented products like AstraZeneca, or a unique distribution network like National Grid.
Price also matters as my yield will be determined by what I pay for a share.
The sort of 8% yield I used in my example above is not common. But I do think it is achievable. I currently own FTSE 100 shares with an 8% yield, or better, such as M&G and Legal & General. I am using them to build my second income today!
