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One way to earn a second income is to build a portfolio of blue-chip dividend-paying stocks.
The amount an investor needs to invest to achieve a particular goal depends on a few things. One is the potential dividend yield at the time of investment. Another is whether that potential return ends up being achieved. After all, no dividend is ever guaranteed.
Understanding the role of dividend yield
Let's start with performance.
At a 10% return, a second annual income of £5,000 would require investing £50,000. At a 7.5% yield, £75,000 would be needed. With a 5% return, the amount required increases to £100,000.
So does it make sense to simply invest in companies with 10% returns, such as FTSE 100 insurer Phoenix (LSE:PHNX)?
Maybe… but maybe not.
Investing solely based on performance alone is a fool's game. Dividends can be cut or canceled, so the future Current performance may be very different from current performance in the future.
That said, I might be interested in whether a good company selling at an attractive share price also offers a high return. I don't invest fair due to performance. But I wouldn't be discouraged by just high performance either.
In fact, it might make the stock more attractive to me for generating a second income.
Quality above all
Phoenix is an example of this, as it is a stock that I think investors should consider.
The company operates in a large and complex market. That complexity acts as a barrier to entry, although there are still many rivals in the insurance market.
But Phoenix has a number of advantages. One of them is its large customer base, which is around 12 million. Another is its collection of trusted brands, including Standard Life and SunLife. It also has a proven business model that has helped underpin annual dividend growth in recent years, a feat the company aims to replicate in the coming years.
No stock is risk-free, and a double-digit return makes me wonder if I've missed something that other investors see as a big risk.
One concern I have is the impact any housing market downturn could have on the valuation assumptions used in Phoenix's mortgage book. If those assumptions need to be revised, that could be bad news for earnings.
Spreading the risk
Overall, though, I see a lot of positives about the investment case for Phoenix.
But things can change, so no matter how much I like a stock, I always keep my portfolio diversified. With the average return on the FTSE 100 currently hovering around 3.6%, a return of over 10% is exceptional. However, an average return of 7.5% is less exceptional.
I think you could aim for a second annual income of £5,000 by investing £75,000 in the current market. I won't do it all at once, but taking into account the annual ISA allowances, I'll build it up over time.
