The idea of earning a second income by investing in shares has a few advantages.

I can benefit from the hard work and expertise of large, proven businesses like Tesco and Vodafone. Helpfully, I can do so even if I have only limited funds to invest.

If I had a spare £5 a day to put towards building a second income, here is how I would go about it.

Regular saving habit

A fiver a day may not sound like a lot – but it adds up.

In a year, saving that amount would give me over £1,800 to invest. Over a decade, putting aside £5 every day would mean I had over £18,000 to put to work in the stock market.

I would aim to get into a regular habit. To do that, I would set up a share-dealing account or Stocks and Shares ISA.

Dividend source

My second income would come in the form of dividends.

When a company makes a profit, it can reinvest the money in its business or share it out among shareholders. Dividends are basically a way in which shareholders can financially benefit from a company generating excess cash.

So, when looking for companies I think might pay me big dividends in future, I consider their business models. Do they have some sort of unique attribute like the technology of Microsoft or brands such as Guinness brewer Diageo?

What about a firm’s balance sheet? If a company has large debts to service, it could mean that even big profits do not end up funding dividends.

Share valuation and yield

Even when I find a business I like, I will not add its shares to my portfolio unless I think the valuation is attractive.

After all, although my focus here is on building a second income, I would also hope to reduce the risk of capital loss. If I buy shares that are priced too high, I may earn dividends from them but find that in future if I sell the shares I get less for them than I paid.

Valuation also matters because the price I pay for a share helps determine the dividend yield I will earn from it.

Yield is an indication of how much second income I can earn in a year. If I invest £1,825 (a year’s savings of £5 daily) at a 5% yield, I could earn £91 in dividends annually. At a 10% yield, though, I would earn twice as much.

Long-term approach

Not many blue-chip FTSE 100 shares pay a 10% yield but there are some. Vodafone, for example, yields 11% at its current share price.

Indeed, I think some UK share price valuations (and therefore dividend yields) are currently very attractive, which is why now could be a rewarding time to start building a portfolio to generate a second income.

The post My £5 a day second income plan appeared first on The Motley Fool UK.

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More reading

• Here’s how I’d aim to start earning £100 in weekly passive income
• I’m taking advantage of this rare opportunity to buy FTSE 100 stocks
• Dirt cheap UK dividend shares to buy before it’s too late?
• How to target £1m by investing £750 a month in a Stocks and Shares ISA
• Investing in penny stocks? 3 critical metrics to watch closely

C Ruane has positions in Vodafone Group Public. The Motley Fool UK has recommended Diageo Plc, Microsoft, Tesco Plc, and Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.