Instead of working more hours each week, owning income shares and collecting the dividends from them could be a way for me to build my earnings.
But how might that work in practice? Below I lay out an example where I target £500 in dividend income each month.
Setting a target income
I think it can be helpful as an investor to set a target. That way, when I invest, I know what I am hoping to achieve and can design my investing strategy against that.
When setting a target, I want to make sure it is achievable. I see no point in hoping to earn £10,000 a month in income if I only have £1,000 to invest, for example. If I set a realistic, achievable target, then with fortune, over time I can increase my wealth. In that case, I may have the financial means to help me target higher amounts in future.
£500 a month of income adds up to £6,000 a year. That is a substantial amount – and I think I would need to invest quite a bit of money to try and hit it with the dividends from income shares.
Understanding dividend yields
Exactly how much I need to invest would depend on the average dividend yield of the shares I buy.
That is basically the annual dividend expressed as a percentage of the price I pay for the shares. So, for example, if I pay £100 for shares and earn £3 a year in dividends from them, we say that the yield is 3%.
With a 3% yield, hitting my target would require me to invest £200,000. If the average yield was 5%, I would need to buy £120,000 worth of income shares. I could hopefully hit my target by spending £60,000 on shares with an average yield of 10%.
Hunting for quality income shares
So, should I just buy the highest-yielding shares, whatever they are?
Absolutely not! Knowing a dividend yield helps me understand what I might earn from a share, but it tells me nothing about the underlying business. Dividends are never guaranteed, so if I invest in a business that fails to make enough profits in future, it could cut or cancel its dividend.
Instead, I always look for a company in an industry I expect to do well in future. If the company has a competitive advantage, that could help it make profits. Then I look at the share price, to see whether I think it offers me value. Only at that point would I consider its dividend yield.
So, for example, a share I own is polymer-maker Victrex. I expect demand for polymers to be resilient and Victrex has patents meaning only it can legally make certain products. The yield is 3.4%. I own other income shares with higher yields, but I think a 3.4% yield from what I see as a quality company is attractive.
But no matter how much I like Victrex — or any other income shares — even a great company can run into unexpected problems. So to try and hit my monthly target, I would invest across a diversified range of companies. And remember that first and foremost, I would be hunting for quality businesses I thought had a bright future.
The post How much would I need to invest in income shares to earn £500 a month? appeared first on The Motley Fool UK.
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C Ruane has positions in Victrex. The Motley Fool UK has recommended Victrex. 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.