Here's how I'd invest $5,000 in ASX 200 shares to earn a second income

I believe these sectors might present a passive income buying opportunity.

| More on:
A young woman sits with her hand to her chin staring off to the side thinking about her investments.

Image source: Getty Images

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Key points

  • The ASX 200 tumbled 7% in 2022
  • Meanwhile, some of the market's sectors experienced far greater struggles
  • I believe their suffering might have produced a silver lining for investors seeking a second income

Last year was a crazy one for S&P/ASX 200 Index (ASX: XJO) shares. The index slumped 7% over the 12 months ended Friday despite soaring energy and mining shares.

Meanwhile, stocks in other sectors – like retail and tech – suffered. The S&P/ASX 200 Consumer Discretionary Index (ASX: XDJ) tumbled 24% last year while the S&P/ASX 200 Information Technology Index (ASX: XIJ) plunged 36%.

But I think the downturn may have provided an opportunity to build passive income. Here's how I would invest $5,000 in ASX 200 dividend stocks if I were aiming for a second income stream.

Is now a good time to buy ASX 200 shares for dividend income?

Inflation, interest rate hikes, and major global events boosted some ASX 200 shares in 2022 while dragging others lower.

Fortunately, the market's long-term performance may sow hope in the hearts of investors. The ASX 200 has historically always returned to and surpassed its previous highs following a downturn.

That means many of the market's embattled sectors likely house some bargain shares right now.

And there's a further silver lining for investors hunting a second income. Falling share prices tend to drive dividend yields higher.

Many companies' dividends remained stable through 2022's downturn, thereby potentially letting investors get a slice of the pie for less than they might've otherwise paid.

Thus, I believe now could be a good time to shift through the rubble in search of quality ASX 200 dividend shares trading for cheap prices. By doing so, I believe I could turn $5,000 into a passive income stream through the power of compounding.

Compounding returns

There's no shortage of ASX 200 shares currently trading with dividend yields of around 8% following a disastrous 2022.

They include JB Hi-Fi Limited (ASX: JBH), Nine Entertainment Co Holdings Ltd (ASX: NEC), and Fletcher Building Limited (ASX: FBU), to name a few.

An 8% dividend yield would see a $5,000 investment returning $400 over the next 12 months.

That's not exactly life-changing. However, I would aim to compound my dividends by reinvesting them in ASX 200 shares.

By doing so, and assuming my yield stays the same, I could turn my initial investment into $10,795 in 10 years' time. At that point, it would be capable of paying out around $864 each year.

But the true magic comes later. In 30 years' time, my figurative $5,000 investment – reinvested time and time again – could be worth $50,313. That, with an 8% yield, could return $4,025 annually.

And that's without considering share price growth or a consistent investment strategy.

Choosing wisely

The ultimate challenge I face in putting my strategy to work is to identify oversold buys in the current environment.

While a high dividend yield might herald an oversold stock, it might also suggest a company isn't spending its cash wisely, making its offerings unsustainable.

Thus, I would pay particular attention to a company's cash flow and balance sheet to help determine if it's a buy right now.

Motley Fool contributor Brooke Cooper has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Jb Hi-Fi and Nine Entertainment. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

More on Dividend Investing

A mature-aged couple high-five each other as they celebrate a financial win and early retirement
Dividend Investing

5 top ASX dividend shares to buy right now

Analysts think income investors should be loading up on these shares.

Read more »

Two adults and a child look happy as they walk through airport with child sitting on suitcase.
Dividend Investing

Will Qantas shares pay a dividend in 2024?

Will the dividends return this year? Let's find out.

Read more »

A woman sits at her computer with her chin resting on her hand as she contemplates her next potential investment.
Dividend Investing

2 market-leading ASX dividend stocks to buy in April

Analysts have put buy ratings on these market-leaders.

Read more »

Father in the ocean with his daughters, symbolising passive income.
Dividend Investing

I'd spend $8k on these ASX 200 shares today to target a $6,102 annual passive income

I believe these ASX 200 shares will continue rewarding passive income investors for years to come.

Read more »

Man holding Australian dollar notes, symbolising dividends.
ETFs

Want the latest dividend from the Vanguard Australia Shares ETF (VAS)? Here's what you have to do

If you want to bag the latest VAS dividend, here's what you need to do.

Read more »

A smiling businessman in the city looks at his phone and punches the air in celebration of good news.
Dividend Investing

Investing for passive income? Keep any eye out for that boosted Telstra dividend today!

If you own Telstra shares, keep an eye out for that juicy dividend payout today.

Read more »

A happy construction worker or miner holds a fistfull of Australian money, indicating a dividends windfall
Dividend Investing

Invest $12,000 in Woodside stock and get $5,700 in passive income

Reliable dividend shares are everywhere on the ASX. Here's how you could use that to your advantage.

Read more »

Australian dollar notes in businessman pocket suit, symbolising ex dividend day.
Dividend Investing

3 ASX 300 dividend shares to buy in April

These shares have been named as buys by brokers and tipped to offer very attractive yields.

Read more »