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Earning a second income can certainly be helpful, especially in the current economic climate.
I currently have multiple sources of income, but my favorite by far is owning dividend stocks. This way I can earn a portion of a company’s profits each quarter in the form of dividend payments.
How would I plan a second income from stocks?
If you wanted to turn a £20,000 stocks and shares ISA into a regular second income, this is what you would do.
Firstly, if my goal is to earn £10,000 a year, I should point out that this would be highly unlikely with a single £20,000 investment. But given the average long-term investment return of 8%, I estimate that it should be possible with around five £20,000 investments a year.
Next, I have to decide what to invest in. Many UK investors look at large cap companies first. FTSE 100 index. It currently offers a dividend yield of around 4%. But over the last decade it has only managed to grow 5% annually, including dividends.
That’s far from the 8% yield I’m targeting.
That said, within Footsie, there are several excellent dividend stocks.
Footsie Dividends
For example, the mining giant Rio Tinto offers a 6% dividend and potential earnings growth. Over the past decade, it has provided shareholders with an annual return of 10%, including dividends.
Although future performance is not guaranteed, it looks like a quality business at a reasonable price. And I wouldn’t be surprised to see more of the same in the next decade.
Other Footsie stocks that could provide a sizeable second income include Legal and general with its 9% yield. This retirement and investment business offers a progressive dividend policy and has a long history of increasing payouts over the years.
One thing to keep in mind is to not just look at a company’s performance. It is also important to consider how the business might perform in the coming years.
Potential value traps
Investors should be aware of potential value traps. These may seem like a good investment at first glance, but they may not be good long-term investments.
For example, imperial marks offers a dividend income of 8%. And while Imperial can comfortably afford these payments with current profits, in my opinion its business could struggle in the coming years.
The tobacco business is heavily regulated and its competitors appear better positioned to benefit from the shift to newer products. So overall, I think I’ll let it go.
Dividend Kings
Lastly, I wouldn’t just stay in the UK. There are also dozens of excellent dividend stocks in the United States, especially for long-term investors.
Many of them include dividend kings. This is a select group of quality stocks that have increased their dividends for 50 consecutive years.
Examples include Coca Cola, Walmartand 3M.
Dividend growth stocks like these typically offer a modest yield, but over time overall earnings are likely to grow.
Consider Warren Buffett’s investment in Coca-Cola. When he bought these stocks 35 years ago, he was offering a 3% dividend yield, much like today. But due to rising dividends, earnings, and share buybacks, his annual dividend payout now represents a nearly 60% yield on cost.
That’s impressive and exactly what I’d like to do to generate a solid, long-term second income.
