Who doesn’t love the idea of earning a second income? With interest rates pushing up the cost of living, dividend stocks are becoming an ever-increasingly attractive proposition, especially those with an enticing yield. After all, investors simply have to just buy and hold these assets to earn some extra cash passively.
But how much money can investors actually make with this investing strategy? And what are some of the pitfalls to be on the lookout for? Let’s explore
Unlocking a £11.9k a year
Let’s say an investor’s been savvy. And after a year of saving, they now have £10,000 sitting in a Stocks and Shares ISA ready to be invested without having to worry about capital gains or dividend taxes.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Initially, the amount of income generated from a £10k portfolio may not be that spectacular. If investing in a passive index fund, they’re likely to only earn around £350 a year based on the FTSE 100’s current 3.5% yield. Venturing into the world of stock picking could realistically boost this to between £500 and £600, but that’s still not a life-changing sum.
However, with a bit of patience and dividend reinvestment, that can change drastically in the long run. Let’s assume the same portfolio earns an extra 4% in capital gains. In that case, after 10 years, this secondary income stream could grow to as high as £1,670. After 30 years, investors could earn closer to £4,400. And if left for three decades, then that’s an estimated £11,900 a year paired with a near-£200,000 nest egg.
Obviously, this is far easier said than done. Even if a portfolio successfully manages to generate a near- 10% annual return for 30 years, all it takes is one poorly-timed market crash or correction to derail a portfolio. However, given time to recover, a portfolio could eventually bounce back from these adverse events, leaving the investor in a far better financial position in the long run.
Finding winning dividend stocks
Looking across the FTSE 350, UK investors are spoilt for choice. There are plenty of companies offering near-6% yields right now with the capacity for decent capital gains growth. One such example to consider would be Victrex (LSE:VCT).
The shares of the leading polymer manufacturing enterprise have delivered an average of around 4.5% in capital gains each year over the last three decades. When paired with the stock’s current 6.2% dividend yield, it certainly makes it look like a viable candidate for a portfolio seeking 10% returns.
Sadly, past performance is a pretty poor indicator of future results. And recent lacklustre business performance has dragged the share in the wrong direction, creating an impressive yield in the process.
Weak demand among consumer electronics is translating into weak demand for Victrex’s products. And since manufacturing these materials comes paired with a high level of fixed costs, the firm’s profit margins have suffered.
On a more positive note, there are some early signs of market recovery. At the same time, management’s been reigning in expenses, enabling it to maintain the current dividend yield. Providing these trends continue, the Victrex share price should be able to bounce back.
But there are obviously no guarantees. And with other dividend shares looking more reliable right now, I’m looking to earn a second income from different companies.
This post was originally published on Motley Fool
