The idea of earning more money may be appealing – but working longer hours may not be an ideal solution. That is why I am trying to build a second income by investing in shares that can pay dividends.
Here is how I am going about that, to try and build lifelong income streams.
Dividends as a second income source
The thinking behind this approach is fairly straightforward. When a company makes a profit, it has to do something with it. It can invest it in the business, save it for future use, pay down its debt, or distribute it to shareholders.
So by becoming a shareholder in a big company like Microsoft or Tesco, I can try and participate in some of its financial success. If I buy the shares today and do not sell them, I will be entitled to any dividends the business pays in coming years. In theory, I could buy Tesco shares today and still be receiving dividends for the rest of my life, on the back of that one share purchase.
Balancing risks and rewards
But will what happens in practice match the theory? Nobody knows. No company is bulletproof and there is also no guarantee of dividends even from a successful business that has paid them before.
Maybe Tesco will see its profit margins fall due to online competition. Or it could decide that instead of funding dividends it prefers to channel spare money into developing new markets.
I try and incorporate that risk into my plan in two main ways. First, my second income share portfolio is spread across a range of businesses. Hopefully, even if some do worse than I expect, others may perform better. I also spend time researching possible share purchases to try and improve my chances of success.
Finding dividend shares to buy?
What is the secret sauce when doing such research? Actually, it is no secret.
I follow the sort of investment method used by successful share pickers such as Warren Buffett. I focus on finding companies in markets I expect to benefit from enduring customer demand. I look for them to have a competitive advantage that can help them set profitable prices, even in a crowded marketplace.
I do not like to overpay, so I try to buy only when what I think are great businesses are on offer at an attractive share price. That is why I focus on what I see as cheap shares, meaning I think they offer me more long-term value than I pay for them.
Not all companies pay dividends. So with building a second income as my objective, I also focus on shares that I expect to pay dividends in future. Helpfully, many companies have a dividend policy where they set out their goals when it comes to dividends.
Making a start
The size of a second income based on dividends would depend on how much I invested and what the average dividend yield of the shares I bought was. If I begin by investing hundreds not thousands of pounds, I may only earn a few pounds a year. But it would be a start.
No matter how modest my first investment was, I would aim to invest more money over time — and hopefully build a substantial second income.