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stocks can be decent vehicles for earning a passive second income through their dividends.
But is £1,000 a year too much for a £10,000 investment? After all, a share would have to return 10% to achieve that, and not many companies can do that.
I honestly didn't expect to get this much right away, although I may be close.
Big dividends and volatility
For example, a well-known and popular dividend payer Legal and general (LSE: LGEN) has a share price of around 228p (26 June). At that level, the expected dividend yield to 2025 is just over 9.6%.
If all the money was invested in shares, it would generate a total annual dividend of approximately £960. However, transaction costs would reduce that yield a little in the first year, but not by much.
Why is Legal & General's dividend yield so high? According to a rule of thumb that investors often use, any yield above 7% could indicate risks as well as opportunities.
Perhaps the biggest uncertainty is that the company operates in the financial sector, known for its cyclicality and volatility.
Cyclical companies often see their earnings rise and fall as the overall economy goes through its usual boom-and-bust twists.
That's why the company's valuation always seems so low and attractive, and the dividend yield so high. It's the stock market's way of pricing the possibility of future earnings, cash flow, dividends, and share price declines.
To be honest, I hope the market is right one day. However, that wouldn't deter me from investing in stocks now. Although cyclicality is a big ongoing risk that can make me lose money on the stock.
I believe we may be in the early stages of a lasting period of multi-year prosperity for the economy, individuals and businesses. So to me, Legal and General seems like a decent stock to research and consider right now, despite the risks.
In order to manage uncertainties
That said, there is no way all my eggs are going into one basket. £10,000 is not at my disposal every day, so I would try to be careful with it and embrace the stock pickers friend: diversification.
In other words, I would spread the investment across several stocks with attractive dividend prospects. For example, my watchlist includes names like energy company National Network and supermarket chain J Sainsbury.
I like them, but it is worth remembering that all businesses and stocks carry risks as well as opportunities. Therefore, my plan would be to do extensive research before buying in an effort to try to reduce the effect of some of the worst investments I could make.
Finally, I would play the long game with my investments. The compounding process is one of the main factors that could help increase the value of my portfolio's dividend income. So I would reinvest the dividends along the way so that the dividend stream hopefully expands over time.
That would be my plan to achieve a second annual income of £1,000 from an initial investment of £10,000.
