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One of my preferred ways to earn an additional income is by investing in dividend shares. And the first place I look to do so is within my Stocks and Shares ISA.
That’s because no dividend tax applies in this tax wrapper, which makes it an efficient place to begin.
The beauty of dividends is that they allow investors to earn a portion of a company’s profits. Building a successful business isn’t easy, but by owning shares I can participate without doing much of the hard work.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Simplifying dividend investing
With thousands of potential shares to choose, the options might seem endless. But there are ways to simplify the process.
For instance, I could own a dividend fund that replicates the performance of dozens of shares.
As an example, ishares UK Dividend UCITS ETF (LSE:IUKD) currently has a 5.7% dividend yield and owns several large FTSE 100 shares such as HSBC, Rio Tinto and Legal & General.
A more global option could be Vanguard FTSE All-World High Dividend Yield UCITS ETF (LSE:VHYL). This yields 3.7%, but it includes some global giants that tend to grow faster such as Exxon Mobil, JPMorgan Chase and Broadcom.
Food for thought
It’s important to consider the total return too. This includes share price gains in addition to dividends. Companies that can grow their earnings can generate higher share prices. And many of these choose to steadily raise dividend payouts too.
In the long term, growth in dividend payments can have a significant impact, so it’s not something to ignore.
Overall, combining dividends and share price returns, the long-term average stock market return has been around 8%.
Bear in mind that this isn’t a guaranteed return. And while some years have produced double-digit gains, other years have suffered losses.
But as stock market history goes back many decades, I reckon it’s a reasonable assumption to make.
Planning my ISA
I’m targeting a five-digit yearly second income in my Stocks and Shares ISA as a supplement to my pension. I know it won’t appear immediately. Time is the magic ingredient in this recipe, especially if I’m planning to invest £300 a month towards it.
One of the main reasons for drip-feeding a sum every month into buying shares is to promote discipline. I’m more likely to remember to do it if it’s a regular thing. And if I have a plan for the long term, I think I’m more likely to stick to it.
By diligently investing every month for 20 years, I calculate that I’d potentially build a pot worth around £165,000. And assuming an 8% annual return, that should be more than sufficient to generate a £13,179 second income.
To target an 8% yearly return, I’d buy both of the funds mentioned above. But in addition, I’d also buy a handful of the very best dividend shares that I like. This involves some further homework and for that I’d look at sources that include The Motley Fool.
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