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Investing money in dividend shares can be one way to try and earn a second income. How lucrative can it be? That depends on how much is invested and what the return on it turns out to be.
To illustrate, let me use the example of £8,000 invested for 10 years. At a compound annual growth rate of 7.5%, after a decade, the investment ought to have grown to a size where a 7.5% dividend yield would generate an annual second income of £1,237.
Dividends and possibly share price growth too
That compound annual growth rate consists of any dividends paid and potentially share price growth too. But dividends are never guaranteed, while a share price fall could hurt the compound annual return.
So the smart investor will both diversify across a range of shares and be careful when choosing what shares to buy.
A high-yield share to consider
I do think a 7.5% dividend yield is possible in today’s market, even though it is well above the current FTSE 100 average. One share I think investors seeking to build a second income should consider is FTSE 100 financial services group Legal & General (LSE: LGEN).
Right now, it offers a whopping 9.1% yield. That sort of yield can suggest the City has doubts over whether the dividend can be sustained, let alone raised each year as Legal & General aims to do.
That is a legitimate doubt. The sale of a large US business will generate significant cash, but leave a hole in the company’s profit-making ability. Meanwhile, I also see volatile markets as a risk if they lead to policyholders cashing in their Legal & General policies, hurting profits.
But I like the company’s strong brand, large client base, proven business model and the fact that it has demonstrated over time it knows how to generate sizeable amounts of spare cash.
How to get started
Buying shares is only part of the second income approach I am discussing here. I do not like to trade shares regularly if I can avoid it, but it is worth checking investments periodically to see whether the original cases that attracted you to them still hold up.
It is necessary to have a way to buy and hold shares too. So a useful first step towards building a second income would be setting up a share-dealing account, Stocks and Shares ISA or trading app.
Setting realistic goals
In the example above I talked about an £8k investment. Could the same approach work with less, or more? Absolutely. It could also work over a longer or shorter timeframe.
At the same rate of return, the more that is invested, the greater the dividend income will be – and the longer the wait period for the portfolio to compound, the larger it ought to be when the drawdown begins, taking the dividends as cash.
