Investing is one of the simplest ways to earn a second income. It doesn’t require me to take a second job or anything like that. It’s simply about investing in stocks for a solid and stable return. The issue for many of us is the fact that we need a lot of money to generate a significant passive income.
In short, the best dividend yield I could look to achieve when investing in a basket of stocks is around 8%. So, even with £50,000 invested, I’d only be earning around £4,000 a year as a second income.
How to double it
If I were looking to double my second income through investing, there are several things to bear in mind.
Firstly, dividend payments from well-run companies often increase. That means if a company continues to raise its dividend payments, my dividend yield will increase in turn.
So, if I pay £1 for a share with an 8p dividend which increases at 10% a year, it’d take seven years for that dividend payment to reach 16p. In other words, this means my dividend yield will have gone from 8% to 16%.
As such, it can certainly pay me to research companies with stable dividends and a history of increasing the dividend payments year on year.
Take this example. Legendary investor Warren Buffett invested $1.3bn in the Coca-Cola shares 30 years ago in 1994. And today, he receives $736m annually in dividends from the investment. That’s a dividend yield in excess of 50%.
I could also combine this with a compound interest strategy and regular contributions. In other words, by reinvesting my dividends year after year and contributing a little of my salary every month, I could double my second income much sooner.
Investing right
If I invest poorly, I could lose money, and therefore, doing my research is really important. In this scenario, I should be looking for a Dividend Aristocrat. This is usually defined as a company that has consistently increased its dividend payments every year for at least 25 years, but given the pandemic and the 2008 financial crisis, there aren’t many of them.
Legal & General (LSE:LGEN) almost fits the description. The dividend payment has expanded from 16.42p in 2018 to 19.37p in 2022. This currently represents an 8.27% dividend yield, making it one of the strongest on the FTSE 100.
The dividend payment roughly grew 5% annually over the period listed above. So, if that were to continue, the payment would reach 30.4p within nine years. In turn, this would be a 13% dividend yield based on the price I’m paying for the stock today.
However, if we factor in some reinvestment — in other words, I have my dividend reinvested each year — I think we could easily be looking at returns that are double the current 8.27% within five or six years. It’s not a perfect science as there are so many moving parts, but it does work.
I appreciate UK insurers don’t have the best records for share price growth. The stock is actually down 10% over five years, broadly mirroring the underperformance of the FTSE 100. However, I’m buoyed by a fair dividend coverage ratio of 1.98 and the strong cash flows the sector generates.
