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A second income could act as a practical financial supplement. One way is to take a second job. But there is more than one way to skin a cat. It is also possible to earn a second income by investing in dividend stocks.
You could start with a few thousand pounds (or less). For example, if you had an extra £3,000 to invest in dividend stocks now to try and generate a growing second income, this is what you would do.
Set up a trading account
My first step would be to put that £3,000 into a shares trading account or stocks and Shares ISA. That way I could use it to buy stocks as soon as I found some that I decided to buy.
I would spread my money across a few different stocks to reduce my risk if one of them disappointed me. That can happen, even with what may seem like a brilliant stock.
Building income streams
How much I could earn as a second income depends on the average dividend yield of my portfolio. At a 7% yield, for example, £3,000 should earn me £210 each year in dividends.
If I wanted to try to increase my passive income, I could reinvest the dividends (known as compounding). For example, if I have compounded £3,000 at 7% a year over a decade, after 10 years I should be earning a second income of around £413 a year.
growing what I earn
I could also aim to increase my second annual income by investing in stocks that I hoped would increase their pay per share in the coming years.
For example, brewer and distiller. Diageo (LSE:DGE) has increased its dividend per share annually for decades. That is no guarantee that it will do so in the future. A company can decide to change its dividend at any time.
So rather than simply looking at current performance (or even looking at yield), my first step is always to identify companies that I think have what it takes to continue generating great free cash flows in the future and that I think can fund a dividend .
With a large market of potential customers, unique brands and a large distribution network, I believe Diageo meets those requirements. One cost-effectiveness concern is the reduction in drinking among younger generations.
But with a proven business model and a growing line of non-alcoholic products, I think Diageo is well prepared for the long term.
High performance, but quality first
Diageo's current yield of 3.4% is well below the 7% I used in my previous example, although it is close to FTSE 100 average of 3.6%.
In today's market, I believe a 7% yield is achievable. But I don't invest in stocks just because they have high returns. Rather, my goal first is to find great companies with an attractive share price. Only then do I consider its performance.
