Earning passive income from the stock market is a key objective for many investors, including me. But, what constitutes a good second income from a portfolio of dividend shares?
There’s no right answer to that question — different people will respond with very different sums. However, a good starting point might be an amount equivalent to the UK minimum wage. For someone aged 23 or older and working a 35-hour week that equates to £1,580 per month.
So, if I had £20k to invest, here’s how I’d aim to generate a passive income stream from dividends alone that could match the minimum wage.
Buying dividend stocks
Since passive income is my goal, I’d concentrate my search on stocks that reward shareholders with regular cash payouts in the form of dividends.
A natural place to start would be high-yield dividend shares, since these companies have the potential to turbocharge my second income aspirations.
There are three FTSE 100 stocks that currently offer mammoth yields in double-digits. They are Vodafone (11.3%), Phoenix Group Holdings (10.2%), and British American Tobacco (10%).
In addition, there are even more dividend shares with bumper yields in the mid-cap FTSE 250 index. One that stands out is Diversified Energy Company, which offers a simply enormous 30.7% yield!
However, a mega yield can often be a warning sign. Rising yields can result from big share price falls, which may be an indication of a business in financial difficulty with unsustainable shareholder distributions. Indeed, all of the above stocks have slumped considerably over the past five years.
Accordingly, I’d also seek greater safety in Dividend Aristocrats that have lower yields but more reliable track records. Even then, while they might be less risky, it’s important to remember that no dividends are ever guaranteed.
The compounding journey
So, now I’m armed with some dividend investment ideas. But, how long would it take for me to generate a second income of £1,580 a month?
Much would depend on the yield I secured across my portfolio, but a well-chosen mix of dividend shares might provide me with a 5% yield.
That figure can fluctuate. Companies’ payouts are unlikely to remain static. Nevertheless, it’s a reasonable number to use for modelling purposes.
At a 5% yield, I’d need a portfolio worth £379,200 to earn the equivalent of the UK minimum wage as passive income.
With £20k to invest and a long time horizon, I could eventually reach my desired target. For example, by harnessing the power of compound returns from years of capital gains and dividend reinvestments, it’d take me around 31 years at a 10% annual growth rate.
However, my returns are unlikely to be consistent and linear. Plus, a 10% growth rate would require me to beat the historic returns of the FTSE 100 index. That’s no mean feat and would demand some very savvy stock picking.
To cut the amount of time it would take or boost my chances of success, I could make smaller additional contributions along the way.
Nonetheless, it’s still possible to earn £1,580 a month by investing £20k and not a penny more — but I’ll need patience and discipline to get there!
