I’m building a second income from UK dividend stocks to top up my State Pension in retirement, and I’m aiming high.
I think it’s possible to build a high and rising passive income by investing the equivalent of a tiny sum every day. Say £2.50, less than the price of a coffee. The key is to sustain it long term.
I’m building a balanced portfolio of mostly FTSE 100 blue-chip stock that offer me a combination of dividend income and share price growth, plus some smaller growth stocks from the FTSE All-Share.
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While I’m working, I’ll reinvest every dividend I receive, which buys me more shares. With luck, they’ll pay me more dividends in future, which will buy more shares, which will pay more dividends… in an endless virtuous cycle.
I’m building my retirement on FTSE 100 stocks
I invest monthly by direct debit, so I don’t give the process a second thought. When I have spare cash, I invest more.
I target shares that I can buy and hold long term, to let my dividend income and share price growth compound.
One FTSE 100 dividend growth share I wished I owed but sadly don’t is distribution group Diploma (LSE: DPLM).
It’s hardly a household name, which perhaps isn’t surprising because it makes unglamorous industrial products such as seals, gaskets, filters, wiring and connectors for businesses in North America and Europe. It’s easy to overlook its dividend potential, given the modest trailing yield of 1.3%.
However, that’s largely down to stonking share price growth. The stock’s climbed 52.95% in 12 months. It’s up 170% over five years.
Yields are calculated by dividing the dividend per share by the share price. So if the price rises, the yield falls.
Dazzling share price growth conceals Diploma’s stellar dividend track record. Over the last decade, the board’s increased dividend payouts by an average rate of 13.7% a year, according to AJ Bell. The total return in that time is 620.2%.
Dividends aren’t guaranteed and AJ Bell forecasts they will grow at a slower pace in future, rising 5.2% in 2024 and 5.4% in 2025. Diploma plans to grow through acquisitions, but this always involves an element of risk, as bolting on a new business takes time and doesn’t always generate the anticipated rewards.
Watch those dividends grow
The average long-term total FTSE 100 return is closer to 8% a year. Let’s say I invested £2.50 a day for 30 years across a portfolio of 15-20 stocks and equalled that 8% return.
Let’s also assume that I increase my contribution by 10% every year. After 30 years, I’d have an impressive £363,982.
If I took just 4% of that every year – known as the safe withdrawal rate – I’d get a second income £14,559 a year.
The longer I invest, the better. If I could keep this going for 40 years, I’d end up with £1,159,674, more than three times as much. Taking 4% each year would give me a fabulous second income of £46,387 a year.
Of course, dividends and share price growth are never guaranteed. Stock markets can be volatile. My portfolio could trail the FTSE 100, or it could outperform. Either way, I’d expect my £2.50 a day to grow into something substantial, with minimal effort and sacrifice on my part.
