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Earning a second income can often involve taking on more work. For some people that is fine, but others cannot or prefer not to go down that route. Fortunately, there is more than one way to earn a second income.
One popular approach involves buying dividend shares. That is a flexible method as it can be matched to however much spare cash you are able to invest.
Three key factors on the road to income
How much you put in matters. So do two other elements: the timeline involved and the average dividend yield.
In this example I presume a 15–year timeline. I also presume a 5% yield – but rather than taking dividends out as income at first, they will be reinvested. This is known as compounding and can be a powerful way to build a portfolio.
Say someone puts in £500 a month, compounding it at 5% annually. After 15 years, their portfolio ought to be worth over £132k. At a 5% dividend yield, that could generate a second income of £6,622 a year.
Keeping things realistic
In that example I have presumed £500 a month. In fact, the same approach could work with a smaller (or larger) contribution, but the income earned would vary accordingly.
Is a 5% compound annual growth rate and later dividend yield realistic? I think so, although it is above the 3% yield currently on offer from the FTSE 100 index of leading British companies.
For example, one share I think investors ought to consider for its income prospects is British American Tobacco (LSE: BATS), if they do not have ethical objections.
This week saw the Pall Mall and Rothmans maker reaffirm its guidance for the full year, as part of its interim results.
The company again underlined its plan to continue growing the dividend per share annually. That is no surprise: British American has already been doing so for decades. The share currently yields 5.4%, higher than my target above.
Can it last, though? No dividend is ever guaranteed and cigarette use is declining. The company’s sales volumes shrank 5% year-on-year in the first half, though the pricing power of its premium brand portfolio meant it was able to grow its cigarette revenue nonetheless.
Still, I do see falling cigarette sales volumes as an ongoing risk. However, while in decline, those volumes remain large and may do so for decades yet. British American has also worked hard to grow its non-cigarette business too.
Getting started on the path
It is important to keep a portfolio diversified. I think it is also smart to stick to what you know and understand.
How best to start on this second income journey though? An obvious first move would be to set up a way to actually invest, such as a share-dealing account, Stocks and Shares ISA or trading app.
Then it can be as simple as starting to make regular contributions to it – and going on the hunt for shares to buy!
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Christopher Ruane does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
