UK shares offer some of the highest yields around. In fact, there are 13 FTSE 100 stocks presently (2 May) paying more than 5%. The average of these is 6.4%. With this in mind, how could someone go about trying to earn a second income of £12,548, which is the same as the full State Pension for the 2026/27 tax year?
Let’s see.
| Region | Dividend yield (%) | Payout ratio (%) |
|---|---|---|
| UK | 3.4 | 47.2 |
| Europe | 3.2 | 50.7 |
| Asia Pacific (excluding Japan) | 2.5 | 39.8 |
| Japan | 2.2 | 38.4 |
| US | 1.4 | 27.5 |
Two alternative approaches
With a yield of 6.4%, a portfolio of dividend shares would need to be valued at £196,063 to pay £12,548 a year.
And while some investors like to focus on growth shares when building an investment portfolio, I believe it’s possible to establish an impressive nest egg using dividend shares.
However, the key is to reinvest those dividends. By doing this, gains will compound quickly.
How do the numbers stack up?
For example, let’s assume someone started with £10,000 of income stocks paying 6.4% a year. In year one, they would generate £640 of dividends. Assuming this amount was reinvested, £681 would be paid in year two. During the third year, the income produced would be £725. And so on. You get the picture.
After 25 years, the initial lump sum of £10,000 would grow to £47,516. That’s an amazing return from doing, literally, nothing.
However, it remains a long way short of our target of £196,063.
But if someone was able to supplement the up-front £10,000 with a monthly investment of £213.73, they would be able to build a portfolio worth £196,058.
At this point, they could change tactics and spend the dividends rather than reinvest them. A 6.4% yield on this sum would produce £12,548 a year. I think this would be a nice addition to the State Pension.
Building for the future
One of the FTSE 100’s ‘Lucky 13’ is Persimmon (LSE:PSN), the UK housebuilder. At the moment, it’s yielding 5.6%.
However, as a reminder that dividends don’t come with any guarantees, it had to cut its payout for its 2023 financial year by 66%. The following year it was reduced by 20%.
The fact that the stock’s still yielding over 5% is an illustration of how much its share price has fallen in recent years.
And if the conflict in the Middle East continues, there could be more bad news for shareholders to come. If inflation starts to pick up again it will increase construction costs, interest rates will rise, mortgages will become more expensive, and disposable incomes will be squeezed. Against this backdrop, Persimmon will see both its top and bottom lines affected.
But I remain hopeful. It’s in everyone’s interest for the war to stop. And even the Bank of England, not known for its overly optimistic forecasts, believes the current ‘energy crisis’ is unlikely to see a return to post-pandemic levels of inflation.
Looking further ahead, the fundamentals of the UK housing market are likely to help Persimmon. Analysis by the Centre for Policy Studies reveals that there’s a shortage of 6.5m homes when compared to similar European countries. To close the gap, it’s estimated that 565,000 homes a year will be needed by 2040. Planning reforms will help.
This should help Persimmon build enough houses to enable it to raise its dividend once more. On this basis, I think it’s an excellent income stock to consider.
The post Starting with £10,000, how could someone aim to earn an annual second income of £12,548 from UK shares? appeared first on The Motley Fool UK.
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James Beard has positions in Persimmon Plc. The Motley Fool UK has recommended Persimmon 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.
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