Sunday, February 25

How to build a second income stream with FTSE 100 dividends – The Motley Fool UK

Scene depicting the City of London, home of the FTSE 100

Image source: Getty Images.

Earned income is an essential part of many people’s financial lives. But enhancing that with a second income is desirable. Especially if that money arrives passively — in other words, without expending direct effort to earn it.

There are many ways a person can generate a passive second income. But the best method for me is by collecting dividends from investments in stocks and shares. And I’d target the large and mature businesses represented by companies in London’s lead index, the FTSE 100.

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Aren’t shares risky?

But is investing in stocks and shares a good idea? After all, it’s risky, isn’t it? I bet many of us know someone who has bet and lost a minor fortune speculating with shares over the years. And I acknowledge that the stock market can be used as a betting casino if we have a mind to do so.

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However, many pension funds, insurance providers, banks, investment trusts, sovereign wealth funds and other institutions put billions into stocks and shares every day. The weight of such institutional money is colossal. For example, I saw one report suggesting Institutional investors account for more than 85% of the volume of trades on the New York Stock Exchange. And I suspect a similar percentage here on the London market.

So why do they do it? I’d attempt to answer that question by pointing to the perhaps surprising long-term record of growth delivered by the stock market. For example, billionaire investor Warren Buffett reckons the S&P 500 index produced total returns running near 10% a year since the 1960s. That’s when the figures are annualised and it includes the returns from dividends. 

I doubt the return from the London market has been as high as America’s over that period, but it’s still been substantial. And there’s a lot of interest in the FTSE 100 and other London-listed shares right now because of the comparative lower valuations. Indeed, stocks in London rarely reach the higher valuations often displayed by many of the fast-growing businesses in the US.

Defensive FTSE 100 dividend stocks

However, although we don’t have as many big-tech and other fast-growing enterprises in the UK, we do have many quality businesses with big investment appeal. Therefore, I’d aim to build a second income by selecting dependable, dividend-paying stocks in the FTSE 100. And a big factor when choosing will be the potential a company has to grow its dividends over time.

A key part of the process for me is identifying a consistent dividend flow. I’d likely avoid long-term investments in cyclical companies with high dividend yields. And that’s because of their often famine-or-feast business economics. Instead, I’d target defensive, less-cyclical operators with long dividend records backed by sound trading and financial figures.

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For example, I’m keen on names such as UnileverNational GridGlaxoSmithKline and others. However, it’s worth remembering all shares carry risks as well as positive potential. And all businesses can succumb to operational setbacks from time to time.

Nevertheless, I’d embrace such uncertainties to align my portfolio with the long-term potential of the stock market. And I’d aim to generate a second income stream from my portfolio of FTSE 100 dividend stocks.

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