Earning passive income may seem like a distant prospect with zero in the bank. Nonetheless, it’s never too late to start investing in dividend shares to secure a second income in later life.
With a disciplined savings approach and a long-term investment horizon, turning this dream into reality can happen. But, it’s important to note the potential risks and strategies to mitigate them.
Let’s explore three simple steps I’d follow to aim for £25k in annual dividend income.
1. ISA investing
First, I need to choose an investment vehicle. With a £20k annual contribution allowance and tax-free treatment for dividends and capital gains, a Stocks and Shares ISA might be an appealing option.
Perhaps even better, a Lifetime ISA has a lower £4k contribution limit, but the government adds a generous 25% top-up. However, penalty-free withdrawals aren’t permitted unless it’s for a first-time property purchase, I’m aged 60+, or am terminally ill.
There are many ISA providers and each has its merits. Features worth considering include the range of investments on offer, fee structures, and trading costs. Since ISA holdings are transferrable, it’s possible to change platforms later on.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
2. Buying dividend shares
Now, it’s time to start buying dividend stocks. Less experienced investors might choose a buy-and-forget dividend fund.
In doing so, they benefit from diversification and avoid the potential pitfalls of picking individual stocks. A good option might be Vanguard’s FTSE All-World High Dividend Yield UCITS ETF.
However, by carefully selecting a portfolio of individual shares, investors could potentially beat returns they might get from an exchange-traded fund (ETF). And there’s help on offer too — a Motley Fool Share Advisor membership could be a good place to start!
Regarding my portfolio, I own several individual stocks. Examples include:
- Centamin — 3.8% yield
- Rio Tinto — 6.5% yield
- Tesco — 3.7% yield
I believe the real magic of stock market investing can be found in a long-term approach. This allows investors to benefit from compound returns — the cumulative effect of gains over time.
To illustrate this, imagine I saved £4,000 a year in a Lifetime ISA. Including the 25% bonus, if my stocks grew at an 8% compound annual rate, I’d have a portfolio worth £625k in just over 30 years.
At a 4% dividend yield across my holdings, I’d earn £25k in annual passive income upon reaching this target. So, if I started investing at 30, I’d achieve my goal shortly after my 60th birthday thanks to tax-free dividend income from my ISA!
3. Managing risk
Relying on dividend shares for passive income isn’t risk-free. Companies can cut or suspend their distributions. Plus, stocks can experience prolonged periods of poor returns. This may mean reaching a portfolio that yields in £25k annual dividends could take longer than expected.
To mitigate these risks, diversification and flexibility are important. By not being overly exposed to any individual company, I’m not putting all my eggs into one basket.
In addition, if I increased my contributions along my journey, I’d add leeway to my portfolio that could protect me in the event companies I owned trimmed their payouts.
Overall, provided all goes to plan, building a sizeable passive income portfolio is a realistic objective for committed investors.
