My £10-a-day approach to building a second income

Work longer hours to earn more money? That’s one way to do it. But personally, I prefer to build a second income without spending more time, if possible.

My own approach focuses on buying shares in large, successful companies, hopefully paying dividends far into the future. Doing so does not require me to have a large lump sum to begin with. I can match the approach to my own financial situation.

Here’s how I’m going to do it by saving £10 a day.

Get into the habit of saving

Putting that amount aside would give me over £3,600 a year to invest.

That can be a solid basis for a second income plan. Not only that, I think that developing a regular habit of saving steadily through thick and thin should help me build good financial habits.

Instead of leaving this money on the bed, I would put it into a share-dealing account, or a Stocks and Shares ISA. Thus, I will be ready to invest as soon as I have enough saved and have found some dividend shares I wanted to buy.

Looking for future dividend winners

How can we find such stocks?

Many people think that the stock market is too complicated. But I find it useful to think from first principles. Dividends are usually cash distributed by a company among its shareholders. So I will look for companies that I think have potential for future profits.

As part of that search, I consider future customer demand in certain areas. Does the business have some competitive advantage that can help it meet these demands?

For example, I expect people to want to disinfect their hands and there is only one Dettol brand. It is owned by Reckitt. Likewise, GSK owns patents for some medicines, meaning they are uniquely positioned to benefit from certain health needs.

I also looked at the company’s balance sheet. If it has a lot of debt, the service can absorb the profits that might be paid out as dividends.

Great company, fair price

Just finding a brilliant business is not enough for me to invest though. I also want to buy when the shares sell at an attractive price. With many investors also looking to buy shares in quality businesses, it may be rare to sell cheaply.

But price matters because overpaying can mean a good business makes a bad investment. The price I pay also helps determine the expected dividend yield. The yield is the annual dividend that I will receive, expressed as a percentage of what I paid.

Grow a second income

Let’s say I invest in stocks with an average dividend yield of 5% (I think this can be done now, while sticking to blue UK stocks). The first year my savings should generate an annual profit of over £180.

That will be accepted but it may be more like vacation money than other income.

But over time, as I continue to put in £10 a day, hopefully my dividend income will increase. Dividends are never guaranteed, but if I invest in a strong and profitable business, shareholder payouts can also increase over the years.