More money but no extra work? That may sound too good to be true. But there is more than one way to earn a second income. For example, one method I use is building a portfolio of shares that I hope will pay me dividends in future.
Here is how I could do that, using an ISA with £20,000 in it (although the same approach could work with less money — I would simply earn less).
Getting ready to invest
To start, I would set up my Stocks and Shares ISA and put cash in it before the annual contribution deadline early next month. That way, I would have it ready to invest when I decided what shares to buy as I try to build a second income.
But just because I had put the money into my ISA does not mean that I would rush to invest it. If I had already decided what shares to buy, I might start purchasing them immediately. But if I was still choosing, or the price of shares I liked was not yet attractive to me, I would patiently wait before putting the money to work.
Buying dividend shares
What sort of shares would I be looking for?
My second income would be made up of dividends. So I would want to invest in businesses I felt could make profits for years or decades to come, which they could pay out as dividends.
First I would look for areas I expected to experience high customer demand over the long term. I would then seek to identify firms operating in those areas I felt had some competitive advantage.
For example, Google parent Alphabet has what I see as a strong competitive advantage in an area I expect to see strong demand for a long time. Its shares are also trading at what I see as an attractive valuation.
But there is a final criterion I would use: is the company likely to pay out profits as dividends?
Alphabet does not, for example, as it keeps profits inside the business to fund growth. By contrast, I get juicy dividends from shares I own in mature industries. British American Tobacco is an example.
Building a second income
How much I might earn from this approach depends on several factors.
One is the average yield of the shares I buy. If I put £20,000 into shares with an average yield of 10%, my annual second income should be £2,000. If the yield was 5%, I ought to earn £1,000 each year in dividend income.
A company could stop paying dividends (or worse, go bankrupt) so I would spread my ISA investment over a diversified range of shares. Hopefully that could mean that investing £20,000 today would let me earn a second income for decades to come.
If I chose the right companies with great businesses, they may grow their profits and dividends over time. In that way, I may see my annual dividend income increase.
The post Here’s how I’d use my ISA to build a lifelong second income appeared first on The Motley Fool UK.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. C Ruane has positions in Alphabet and British American Tobacco P.l.c. The Motley Fool UK has recommended Alphabet and British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.