Here’s how I can use £3,000 to target a second income that grows each year

A second income can serve as a useful financial supplement. Another way is to take a second job. But there is more than one way to operate on a cat. It is also possible to get a secondary profit by investing in dividend stocks.

I can start with a few thousand pounds (or less). For example, if I had £3,000 left over to invest in shares now to try and build a growing second income, here’s what I’d do.

Setting up a sales account

My first move would be to put that £3,000 into a brokerage account or a Stocks and Shares ISA. That way I could use it to buy stocks as soon as I found some that I decided to buy.

I would spread my money over a few different stocks, to reduce my risk if one of them disappoints. That is possible, even what may seem like a great job.

Creating inbound ways

How much I can earn as a secondary income depends on the average profit margin of my portfolio. At a 7% yield, for example, £3,000 should earn me £210 each year in dividends.

If I wanted to try to increase my passive income, I could reinvest dividends (known as compounding). For example, if I compound £3,000 at 7% per annum for ten years, after 10 years I should be earning a second income of £413 per annum.

Increasing my income

I would also be willing to increase my second annual income by investing in stocks that I hoped would increase their payout per share in the coming years.

For example, a brewer and a distiller Diageo (LSE: DGE) has grown its dividend every year for decades. That is no guarantee that it will do so in the future. The company can decide to change its shares at any time.

So instead of looking at current yield (or even looking at general yield) my first step is always to identify businesses that I think have what it takes to continue to generate significant free cash flow in the future that I think can support a dividend.

With a large market of potential customers, unique brands and a large distribution network, I think Diageo fits that bill. Another concern for the benefit is the decline in the number of people drinking among the younger generations.

But with a proven business model and growing non-alcoholic product, I think Diageo is well set for the long term.

High yield – but quality first

Diageo’s current yield of 3.4% is less than the 7% I used in my example above, although it is close FTSE 100 an average of 3.6%.

In today’s markets, I think a 7% yield is achievable. But I don’t invest in US shares because they have a high yield. Instead, I first aim to find large companies with attractive share prices. Only then do I consider their harvest.