Are income shares the best way to create a second income? I think so. By holding such shares, I receive dividend payments into my investment account like clockwork. I own a piece of the company, so I get to share in the company’s earnings.

And because I live in the UK, it’s easy for me to buy shares of many excellent income stocks. The FTSE 100 index is full of firms that boast a long history of delivering excellent dividend payments to their shareholders. 

Let’s say I wanted to target £400 a month from my income shares. Here’s how much I’d need.

How much will my shares earn?

The first step in my calculation is to figure out what I’m getting back from my income shares. An easy way to do this is using the annual yield. This is the percentage I get back on my investment over a year. 

So if an income stock has a 3% annual yield, for each pound I invest I’d get back 3p. If I held £1,000 of shares at an annual yield of 3%, I’d receive £30 in dividends yearly. 

The average dividend yield for the FTSE 100 is around 3.5%. That’s probably on the low end though, as it includes growth shares that may not pay dividends as well as income shares. Actually, the total return going back historically for the FTSE 100 is 8%. If we look at the FTSE 250, it’s more like 10%. 

Income stocks, which deliver returns to shareholders in the form of dividends taken out of the company’s earnings, tend to fall somewhere between these figures. A few of the most traded UK stocks are Sainsbury’s with a 5.23% annual yield, Legal & General with its 7.41% yield, and Rio Tinto with its 6.98% yield.

The actual percentage varies, but I’d feel confident I could hit a 6% return. Of course, dividends aren’t guaranteed and it’s common in economic downturns like 2008 for them to be cut entirely. 

Why I prefer to generate a cash return

The £400 per month that I’m aiming adds up to £4,800 a year. So the amount I’d need to invest at a 6% return to generate £4,800 a year would be £80,000. I know people who’ve spent that much on the deposit for a house, but using it to generate a cash return appeals to me more. 

It’s still an amount of money that most people won’t have just lying around. A good strategy to work towards it is to drip-feed savings or disposable income into it. This is something I’ve been doing for years and it’s great to see my total building up over time. 

The trick is to reinvest my dividends along the way, which will grow my investments faster. This is where we see the real magic of compound interest, the “eighth wonder of the world” as some call it.

And once I reach that £400 a month? It’s going to be very tempting to continue to reinvest the returns to get an even higher income from my shares. This can offer me financial stability, a future income alongside my pension, or it could even open the door to retiring early if I so wish.

The post How much would I need to invest in income shares to earn £400 a month? appeared first on The Motley Fool UK.

setButtonColorDefaults(“#5FA85D”, ‘background’, ‘#5FA85D’);
setButtonColorDefaults(“#43A24A”, ‘border-color’, ‘#43A24A’);
setButtonColorDefaults(“#FFFFFF”, ‘color’, ‘#FFFFFF’);
})()

More reading

• Persimmon’s share price has tanked. Is this an investment opportunity?
• 3 reasons Rolls-Royce shares could be worth buying today
• How I’d invest £10k in an ISA today for passive income of £50 a month
• Is Lloyds’ cheap share price the FTSE 100’s greatest bargain?
• Best British value shares to buy for March

John Fieldsend has no position in any of the shares mentioned. The Motley Fool UK has recommended J Sainsbury Plc. 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.