Image source: Getty Images
Working more hours each week is one way to try to earn a second income.
But one approach I prefer is to simply invest in stocks that are expected to pay dividends to shareholders in the future.
If you had less than £10,000 in savings, you may still have enough to go ahead with that approach. Below is an example based on an investment of £9,000.
Use cash to generate dividends
First, let me explain in more detail how this approach could help me generate a second income.
When companies generate excess cash, they have several options for what to do with it. They could build new factories, for example, or finance the acquisition of a rival.
One use is to pay dividends to shareholders. Companies listed on the London Stock Exchange spent more than billion pounds a week on average last year paying said dividends.
Simply by purchasing a share of a company that pays dividends, I have the right to receive the ordinary dividends that it declares for as long as I have them. Still, dividends are never guaranteed, no matter what has happened in the past, so I would diversify my holdings across several companies. My £9,000 would be enough to do that.
Building Greater Passive Income Streams
I already like this plan. If I could achieve an average annual dividend yield of 7%, for example, I would expect to earn 7% of my £9,000 each year – £630.
But I could try to earn even more by buying the same shares and still using my original investment of £9,000. To do this, you would reinvest the dividends, a simple but potentially lucrative investment measure known as compounding.
If, for example, you accumulated £9,000 at 7% a year, after 20 years you should have a share portfolio worth almost £35,000. At a 7% return, that portfolio size would be large enough to earn me around £2,437 as a second annual income.
From today
Time can be an investor's friend, so I would start investing as soon as possible as long as you can find quality income stocks to buy at the right price.
One stock that I have that I think fits that mold from my perspective is Legal and general (LSE: LGEN).
The financial services market is large and I hope it remains so. Thanks to its focus on the retirement segment of the market, Legal & General benefits from long-term growth prospects, substantial cash flows and demand that I expect to be resilient.
You can use your strong brand and large customer base to try to make the most of your position. So far that has worked well: the company is not only consistently profitable, but also offers a dividend yield of 9.2%.
I do see the risk that turbulence in the financial markets could lead some clients to terminate their policies, harming their profits.
But I plan to keep my Legal and General shares in my stocks and Shares ISA for the foreseeable future and hopefully generate my second income.
