One straightforward way to earn a second income is to build a portfolio of dividend shares.
Not only does that involve little real work, it can also be lucrative. Step by step, here is how an investor could use that strategy to target £10K in passive income each year.
A lump sum is one way – but it’s not necessary
The dividend income will depend on how much is invested and what the average dividend yield is.
For example, using a 5% dividend yield, £10K in second income annually would require a £200K investment.
But an alternative method (and the one I use) is to try and build up to the income target over time by making regular contributions to an ISA.
Even £200 per week compounded at 5% annually could lead to a £200k portfolio. Sure, it would take 14 years. But as a long-term investor, that is music to my ears.
Finding shares to buy
An investor could also speed things up if the compound annual growth rate (i.e. share price movement plus any dividends) was higher than 5%. But dividends are never guaranteed – and share prices can go down as well as up.
So I never choose a share just because of its yield.
Rather, I try and find great companies I think have excellent long-term commercial prospects that in my opinion are not properly reflected in their current share price.
A short case study
That sounds well in theory, but what about the practice?
Let me illustrate with a share I own: footwear specialist Crocs (NASDAQ: CROX). Over the past five years, the Crocs share price has soared 149%: far, far above my 5% per year example.
I have missed that gain, as I am a fairly new shareholder. Fine. The thing is, even now, the company trades on a price-to-earnings ratio of just 7.
That seems almost absurdly cheap to me given the iconic brand and product, huge customer base, manufacturing management expertise and patented designs. I do not like Crocs — but I recognise a great business model when I see one.
Still, if the business is so good, why is it selling at that price – and why is it down 36% since June?
Its acquisition of the Hey Dude footwear brand has brought a host of problems and looks like increasingly bad value.
That is a risk to earnings. But I still think Crocs is a great business at a great price and plan to hold the shares.
Getting ready to invest
But wait. Crocs does not pay a dividend. So where would a second income come from in such a scenario?
Recall above I talked about a £200K portfolio invested at a 5% yield. If not starting with a lump sum, the investor does not need to invest in dividend shares immediately.
They can use a mixture of dividend and growth shares to build their portfolio value. Then, at the £200K mark, they could switch to just dividend shares.
If the investor diversifies and chooses the right shares, hopefully that £10K second income will keep coming (and maybe even growing) each year.
But they need a good way to buy and hold those shares, such as a Stocks and Shares ISA.
The post Here’s how much an investor would need in an ISA to earn a £10,000 second income this year (and every year!) appeared first on The Motley Fool UK.
Pound coins for sale — 31 pence?
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
See the full investment case
More reading
The FTSE 100 hit an all-time high this week — but I still loaded up on this share!
Here’s how an investor could find shares to buy for an early retirement
8 pros and cons of buying shares as a passive income idea
Is £280 enough to start buying shares for the first time? Yes – and here’s why!
How an investor could use a Stocks and Shares ISA to target £1,120 in dividends annually
C Ruane has positions in Crocs. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
