Investing in dividend shares can be a great way of earning a second income. Participating in the success of exceptional businesses can be extremely lucrative.
WIth interest rates set to fall, higher share prices have been causing dividend yields to fall. So how much would I need to invest to earn £10,000 per year in passive income from the stock market?
Dividend yield
The short answer is that it comes down to what sort of return I think I could get from a portfolio of dividend stocks. At the moment, the FTSE 100 has an average dividend yield of 3.5%.
At that level, I’d need a portfolio worth £285,714 to earn £10,000 per year. That’s assuming I invest in a Stocks and Shares ISA to avoid having to pay tax on my dividends.
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That’s a lot, but I think it might be possible to do better by focusing on some of the highest-quality stocks in the index. Bunzl (LSE:BNZL) is a good example.
The stock currently has a dividend yield of around 2%. That hardly stands out as a passive income opportunity, but it has an impressive growth record that I think it’s worth paying attention to.
Growth
Over the last decade, Bunzl has gone from paying out 33p per share in dividends to 64p. And it just boosted its interim dividend by a full 10%.
If that continues for another 10 years, the dividend the company pays out to investors in 2034 will amount to a 4.7% return on the cash they invest today. That makes the equation look quite different.
At that level, I could earn a £10,000 second income by investing £212,765. And if the dividend increased by another 5% for 10 more years, the amount would come down to £130,208.
Of course, the Bunzl share price might well go up as its dividends increase. But I think there could be an opportunity to invest today for some great returns over the long term as the business grows.
Risks
Of course, the risk with this strategy is that the business might not grow as anticipated. If that happens, the dividend is unlikely to increase as quickly and I might end up with less income than I’d hope.
Bunzl is a company that generates growth by acquiring other businesses. And the danger is that it either pays too much for an acquisition or runs out of targets to add to its network.
Those are risks that investors should take seriously, but it’s worth noting that management is alive to this possibility. And I think it has been very careful in how it deploys its capital.
Where the company hasn’t been able to find acquisition opportunities, it has returned cash to investors through share buybacks. And that should give shareholders some confidence going forward.
Doing more with less
If I just invested in the FTSE 100 as a whole, I’d need around £285,714 to earn a £10,000 second income. But I think it’s possible for investors with time on their side to do better.
Companies that can grow their dividends in the future can provide serious passive income. Even if the starting yield is low, it can turn into something quite substantial.
This post was originally published on Motley Fool
