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Working hard to earn money is important. However, it is equally crucial for investors to ensure that their money is working hard for them. With this in mind, investing in dividend stocks can be a great way to generate a second income.
Here's how I aim to secure passive income for life through five easy steps.
1. Save regularly
As the old saying goes, there is no such thing as a free lunch. Investment requires capital.
Even stock market veterans started somewhere. Warren Buffett made his first stock purchases at age 11 for a total of $114.
Some things are still true 82 years later. Dividend investing still has low barriers to entry compared to many other forms of passive income generation, such as purchasing rental properties.
By developing good savings habits and putting away even small sums of money in a well-thought-out portfolio, investors can expect to reap long-term rewards.
2. Use an ISA
Few people want to pay more taxes than they should. In that context, it is important to note that the UK's tax-free dividend allowance has been reduced to a paltry £500 per year.
Fortunately, there are ways for investors to limit bills owed to HMRC and maximize their second income potential.
Using a stocks and shares ISA is an attractive option. There are many different brokers to choose from and it is worth investigating which one is the best fit in terms of fees and investment product offerings.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
3. Understand dividends
It is also essential for investors to understand what dividends are and the potential risks they involve.
Basically, dividends are cash distributions that some companies pay to their shareholders from current earnings or retained earnings.
They are not guaranteed. Companies may modify their dividend policies to respond to challenging business conditions. If a company enters financial difficulties, dividend payments may be cut, postponed, or eliminated entirely.
<h2 class="wp-block-heading" id="h-4-find-stocks-to-buy”>4. Find stocks to buy
There are several metrics to consider when investing in dividend stocks, including company performance, distribution history, and dividend coverage ratios.
For a concrete example of a dividend stock worth considering, IG Group (LSE:IGG) is a FTSE 250 company that seems attractive to me at the moment.
The online trading services provider performs well on all key dividend indicators.
It has an attractive yield of 5.6%, comfortably surpassing the average of FTSE 100 and FTSE 250 shares. What's more, it has maintained or increased payouts every year over the last decade and current coverage is 2.1 times earnings, indicating a good margin of safety.
Given the group's reliance on contracts for difference (CFD) trading, it is particularly exposed to volatility in the financial markets. Furthermore, there are clear competition risks, as numerous companies offer similar services.
That said, I think these risks are offset by the current valuation. The relatively low price-to-earnings (P/E) ratio of around 11 could bode well for future returns. Recent share buybacks suggest the board shares this view.
5. Earn a second income
If all goes according to plan, by investing in a diversified mix of quality dividend stocks, investors will begin to earn a steady stream of passive income.
To enhance the effect of compounding returns on their portfolios, investors could choose to reinvest dividends into more stocks. That's what I'll do until I need extra money closer to retirement.
