There are hundreds of dividend shares available to buy on the London Stock Exchange. If I’m targeting a second income, where should I start?
First, I’d do some maths to work out how much I’d need to invest and how much I might expect to earn in passive income.
Quick maths
The average dividend yield in the FTSE 100 is around 4%. But there are dozens of reliable dividend shares that offer yields over 7%.
And if I can pick companies that are also growing their businesses, I might be able to achieve another 3% or so from share price gains, totalling around 10% a year.
Now, if I invest £150 a month, that’s £1,800 a year. As a long-term investor, I know that investing over many years is a much more reliable way to benefit from the stock market than trying to trade frequently.
But don’t just take my word for it. Popular investor Warren Buffett once said his “favourite stock holding period is forever”.
That said, instead of targeting an infinite time period, I’d aim for a more finite 30 years.
I calculate that after 30 years, I could have a pot worth almost £300,000. That should be enough to earn £20,000 in annual passive income from dividends alone.
Finding reliable dividend shares
When looking for the best dividend shares, I’d look at more than just the yields. Some shares offer dividend yields of over 20%. But I’d stay away from those. I’d be suspicious of a yield that high as it’s likely to be unaffordable. Instead, I’d focus on reliable dividends.
I’d want a company I invest in to be able to afford its payments to shareholders. One way to check this is to look at its dividend cover. This measure looks at how well the payment is covered by its current earnings.
A dividend cover of less than one would imply that the business either needs to find additional cash to pay out or that it needs to cut its dividend. Neither are great options, in my opinion.
Next, I’d look for shares that have a history of paying dividends. Companies that have a supportive dividend policy might be more likely to continue offering reliable dividends. In particular, I like shares that have been paying consistently for at least five years.
Bear in mind that companies can still cut or suspend dividends at any time. In the past, many businesses had to do so during times of crisis or uncertainty.
That’s why I’d split my £150 a month across several shares. Diversifying should spread my risk and prevent me putting all of my eggs in one basket.
Which dividend shares?
Right now, shares that meet my criteria include Rio Tinto, Phoenix Group Holdings, Taylor Wimpey, Legal & General group and Imperial Brands. On average, these five shares currently pay an 8.5% yield, and have dividend cover of 1.8. Impressively, they’ve also been paying regular dividends for 18 years, on average.
Bear in mind that businesses can face disruption and things can change over time. I’d need to monitor my stocks to ensure they continue to meet my criteria. That said, right now I’d be happy to buy all five.