Shares can be decent vehicles for passive second income because of their dividends.
But is £1k a year too much of a stretch when investing £10,000? After all, a stock would need to yield 10% to produce that, and not many companies can.
In fairness, I wouldn’t expect to get that much immediately. However, it may be close.
Big dividends and volatility
For example, well-known and popular dividend payer Legal & General (LSE: LGEN) has a share price near 228p (26 June). At that level, the forward-looking dividend yield for 2025 is just over 9.6%.
Putting all the money in the stock would generate a total annual dividend worth about £960. However, the trading costs would eat into that return a little in the first year, but not much.
Why is Legal & General’s dividend yield so high though? In one rule of thumb often used by investors, any yield above 7% might be signalling risks as well as opportunity.
Perhaps the biggest uncertainty is the company operates in the financial sector, which is known for its cyclicality and volatility.
Cyclical firms often see their profits wax and wane as the general economy goes through its usual boom and bust gyrations.
That’s why the company’s valuation always seems to look so low and attractive – and the dividend yield so high. It’s the stock market’s way of pricing in the possibility of a collapse in earnings, cash flow, dividends and the share price ahead.
To be honest, I expect the market will be correct one day. However, that wouldn’t put me off investing in the stock now. Although cyclicality’s a big ongoing risk that may cause me to lose money on the stock.
I reckon we may be in the early stages of an enduring period of multi-year prosperity for the economy, individuals, businesses and companies. So to me, Legal and General looks like a decent stock to research and consider right now, despite the risks.
Aiming to manage the uncertainties
That said, there’s no way all my eggs would go in the one basket. £10,000 doesn’t come available to me every day, so I’d aim to be careful with it by embracing the stock-pickers friend – diversification.
In other words, I’d spread the investment over several stocks with attractive-looking dividend prospects. For example, my watchlist includes names such as energy company National Grid and supermarket chain J Sainsbury.
I like them, but it’s worth me remembering all businesses and stocks come with risks as well as opportunity. Therefore, my plan would be to dig in with thorough research before buying in an effort to try to reduce the effect of some of the worst investment howlers I could make!
Finally, I’d play the long game with my investing. The process of compounding is one of the main factors that could help to build the value of my portfolio’s dividend income. So I’d reinvest dividends along the way so the dividend stream hopefully expands over time.
That would be my plan for getting to an annual second income of £1,000 from an initial investment of £10k.
This post was originally published on Motley Fool
