Setting up additional income streams without having a second job could be a positive thing when it comes to personal finance. If I wanted to build a second income, I would aim to do so through investing in shares.
I think that could be lucrative: indeed, I think I might be able to hit a £500 monthly income target by investing £25 each week. But that is because, as a long-term investor, my timeframe stretches to decades not just years or months.
Even with a shorter timeframe, I think I could still aim to build up a more modest second income through this approach. Here’s how.
The basics
Shares are like a tiny sliver of a company. In this case I am not thinking about small companies like a local chemist or a car hire centre. Instead, my sights are set on the sorts of blue-chip businesses that sit in the benchmark FTSE 100 index of leading shares, or the smaller firms in the FTSE 250 index.
What I hope is that, by owning even a very minor piece of such firms, I can benefit from their business success when they pay out dividends.
I might make some bad choices or have unfortunate luck along the way, so I would invest in a range of companies to help reduce my risk.
As my focus in building a second income is dividends, I would also look not only for great businesses but for great businesses that look likely to share excess cash with shareholders.
Google parent Alphabet, for example, is massively profitable – but does not currently pay a dividend.
By contrast, Vodafone has a dividend yield of 9.6%. That means that, for every £100 I put into its shares today, I would hopefully earn £9.60 annually in dividends. That is, as long as the dividends stay at the current level (which is never guaranteed and one reason I am very careful when choosing the shares to buy).
Working towards a target
I could take any such dividends out as cash to give me a second income.
Imagine I earn an average yield of 8%. Investing £25 a week like that, I would already be earning £10 per week on average in dividends after five years.
But while that would be welcome, it is a long way off my second income target!
The power of compounding
That is why, taking the long-term view, I would compound my dividends. That simply means reinvesting them in buying more shares.
Imagine I put the same amount away each week in identical shares to my above example, but compounded the dividends. After five years, my portfolio would be worth £7,900 and would generate an annual second income of £632.
But what if I could manage a higher average dividend yield, of 10%?
In that case, after 18 years of investing £25 weekly, my Stocks and Shares ISA would be throwing off £500 per month on average in dividends.
Finding high-quality shares that yield 10% is not easy. It takes time, effort, and research. But if I could manage to do it, my second income goal could come closer into view!
