Earning a second income in the stock market’s fairly straightforward. Investors can simply focus on buying and holding dividend-paying enterprises and then watch the money steadily roll in. However, when starting from scratch, the process can be a bit daunting. And simply chasing the highest yields can result in some shockingly bad returns.
So with that in mind, let’s explore some best practices for income investing and how to aim for a £60k long-term portfolio income stream.
Compounding dividends
Across the UK, the average household is able to save roughly £450 a month. Suppose that money is allocated to a FTSE 100 index fund today. In this scenario, investors can expect to earn between 6% and 8% a year moving forward, based on the historical performance of the UK’s flagship index.
Around half of these gains stem from dividends. And at a 4% yield, each £450 monthly investment would unlock roughly £18 of annual passive income. Needless to say, that’s not exactly a life-changing sum. But that quickly changes once compounding enters the picture.
Instead of immediately withdrawing dividends, investors can automatically reinvest them. And with more capital being injected into the wealth-building process, an impressive sum can accumulate over time. In fact, after 30 years of earning 8% total returns, an investor could end up with a £670,660 portfolio generating roughly £26,830 in passive income.
Earning £60,000
Having an extra 26 grand in the bank each year is certainly nothing to scoff at. But by being shrewd and taking on a bit more risk, it’s possible to more than double this second income.
Instead of mimicking market returns with an index fund, investors can take their income portfolio into their own hands. The London Stock Exchange is filled with dividend shares offering yields significantly higher than 4%.
Suppose a portfolio of these enterprises delivers a 6% yield while still delivering another 4% in capital gains? In that case, after 30 years of £450 monthly deposits, a portfolio would reach into the seven-figure territory, generating £60,000 of dividends each year.
Taking a step back
Earning almost twice the average national salary without having to lift a finger is an undeniably awesome prospect. But it’s important to realise that none of it is guaranteed. Let’s take a look at Vodafone (LSE:VOD) as an example.
A few months ago, the telecommunications giant was offering a staggering 11% dividend yield. But anyone who was lured into this income prospect is likely kicking themselves right now, given that dividends have been slashed in half.
With the cost of debt rising considerably, Vodafone’s balance sheet is under a lot of pressure right now. Management has been busy cutting costs, selling off underperforming segments, and changing the dividend policy to try and fix the foundations of the business.
To its credit, Vodafone’s financial position is on the mend. But the outlook for dividends remains bleak. And another payout cut could be on the horizon if performance in Germany continues to deteriorate.
This goes to show that when hunting for higher-yielding income opportunities, particular attention needs to be paid to the quality of the underlying business. A weak balance sheet and constricted cash flows are just two of the potential red flags that can lead investors astray.
This post was originally published on Motley Fool
