The last couple of years have proven that stubbornly high inflation can really stretch one’s budget. Therefore, a second income could probably come in handy for most people, including myself.
However, it might not be desirable or even possible for me to put in more hours at work or take a second job to make this happen.
Fortunately, there is another way. And this involves earning a second income through investing in shares.
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By doing this, I would let world-class FTSE 100 companies like BP and AstraZeneca do the hard work for me! It would be like putting my money to work rather than me working harder for more money.
Here, I’m going to consider how this approach could one day turn an investment of £15,000 into a life-long £5,600 annual second income.
The joy of dividends
When I first started investing many years ago, I focused almost entirely on growing my capital through growth stocks. For me back then, it was about finding the next Intel or Amazon. This often led me to discount ‘boring’ dividend stocks in favour of shares with explosive growth potential.
This approach, I soon came to realise, had severe limitations. I often saw one of my stocks rocket higher, only for it to come crashing back down to earth a few weeks later. I had stocks double in value then fall back below my entry price within the space of weeks.
However, when I receive a juicy dividend payment, it is a concrete return that cannot be taken away. Of course, the share price could always go down, and dividends do get cancelled. But once the payment is in my account, a portion of my return has been cemented.
The top-line growth of established dividend payers is often slower, due to their size and maturity, but their cash generation is usually superb. Coca-Cola, for example, has raised its dividend for 61 years in a row!
Over time, I have come to love receiving dividends in my portfolio. I can spend the cash as I see fit, but the real magic starts to happen when I reinvest these payments into buying even more shares.
The miracle of compounding
When my dividend payments start generating further dividend payments, then I’m harnessing the power of compound interest.
As an example, let’s assume I own a Stocks and Shares ISA portfolio of shares with an average yield of 8%. My initial investment of £15,000 would compound to £70,000 after 20 years.
That’s by just reinvesting my returns, without injecting any fresh money into my portfolio!
If I switch to receiving my cash dividends instead of reinvesting them, my £70k portfolio would be generating £5,600 a year in passive income.
No time like the present
My first move here would be to open a Stocks and Shares ISA. Then I would start looking for stocks that match my risk tolerance.
Nowadays, my own preference is to run a balanced portfolio between growth and dividend stocks. Since I made this switch a few years ago, my returns have improved markedly.
Fortunately, there are literally dozens of opportunities for investors in the UK market today. This includes high-yield dividend shares and growth stocks trading on reasonable valuations.
