The allure of dividend shares is easy to understand. By investing in a company such as Tesco or Apple, I might be able to benefit from its profits – not just when I buy the shares, but hopefully year after year. But what is a practical way to start investing in dividend shares on a limited budget?
Here is how I would do it, with a spare £400.
Focus on business quality, not dividend size
Investors commonly talk about dividend yield, which is the percentage of today’s share price I would hopefully earn each year in dividends. But dividends are never guaranteed. Just because a company made a payout last year – or even every year for decades – does not mean it will keep doing do. As an example, energy company Shell cut its dividend in 2020 for the first time since the Second World War.
So, how would I decide what dividend shares to buy? I would look at the source of such dividends: the spare cash a business generates. Does a company have something that separates it from its competitors and could allow it to keep earning profits long into the future? For example, does it have a unique brand like Coca-Cola or an entrenched customer base like DCC?
Next I would look at the company’s balance sheet. After all, some businesses generate substantial cash flows but need to use them to pay down debt. That could eat into their ability to pay dividends. So I would look at a company’s most recent balance sheet, something that is usually available free online.
How I would start investing
Once I had found some shares I thought could pay me good dividends in future, I would consider buying them for my portfolio.
But, even with a relatively modest sum like £400 to invest, I would not put all my money into one company. No matter how promising I think a business looks, anything could happen to it. Maybe it will make some mistakes in its business strategy. Possibly a new entrant in its market will hurt profit margins. Or some unexpected political event could blindside a previously successful company.
That is why I would diversify my portfolio, so that if any one company performs worse than I expect it does not ruin all my dividend income plans.
Modest expectations
With £400, if I invested in companies with an average dividend yield of 5% — already higher than the FTSE 100 average – I would hopefully receive £20 in annual dividend income.
That may not sound like very much. But it is a start. Hopefully, if I was to start investing and earning dividend income, I could learn more and grow my portfolio over time. The lessons I learn investing £400 could help me once I had much larger sums to put to work in the stock market.