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With a spare £3,000 I’d build a growing second income like this

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Would I like to earn more money? Yes. Would I like to work many more hours to do that if I do not have to? No! That is why I am trying to build a second income by investing in shares I think can pay me dividends in future.

I could start doing that today with whatever spare cash I had available. To illustrate, imagine I had £3,000 and decided I wanted to use it to try and build dividend income streams that grow over time. Here is how I could go about it.

Be clear about risk and reward

To begin, I would want to focus on my investment objectives. For example, am I interested in income now or am I happy to wait a few years to start receiving it?

If I wanted sizeable dividends now, I would be tempted to invest in high yield shares like tobacco maker Imperial Brands. But if I was willing to wait, I might choose to invest in some shares with low dividend yields but that I expect to raise their payout rapidly. Judges Scientific is an example of a share I think could keep raising its cash distribution to shareholders at speed.

Another part of figuring out my objectives is deciding my risk tolerance. Dividends are never guaranteed. On top of that, I might buy shares in the hope of a dividend only to find that if the dividend is cancelled, the share price also falls steeply as income investors sell out. Striking the right balance between potential reward and a risk tolerance that suits my own comfort level is important to help me make the right investment decisions.

Hunting for income shares to buy

Another element of my risk management would be to diversify across a range of shares. With £3,000, I would probably buy shares in three to six different companies.

But how could I find shares that might help me achieve my objective? I would start by looking for companies I understand and that look set to do well in the long term. For that, I always like a company to have a large addressable market but also to have something that can help it stand out from rivals. That can give it pricing power, helping profits. Those are important when it comes to generating spare cash that can fund dividends.

I do look at a company’s dividend history when investing. But past performance is no guarantee of what will happen in future. That is why I always consider the prospects of a firm five, 10 or more years from now.

Building a second income

If I can buy such shares when they are trading at an attractive price, hopefully I can start to build up my second income.

At first that may be fairly modest. For example, investing £3,000 at an average dividend yield of 5% ought to earn me £150 per year in dividend income.

But if I invest in companies that grow their shareholder payouts, that total could rise over time. I could also reinvest the dividends in more shares, which is known as compounding. That could hopefully help me build a bigger second income down the line.

The post With a spare £3,000 I’d build a growing second income like this appeared first on The Motley Fool UK.

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C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Imperial Brands and Judges Scientific. 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.