February 2023 could be an excellent time to start building a second income through ASX dividend shares. It can be done with a small amount of money each week, using the power of compounding to help grow wealth.
I think that investing in ASX shares is one of the best ways to grow our net worth. Many leading companies on the ASX make good profits, but plenty of them also pay dividends.
Australian companies have the added benefit of attaching franking credits to dividends that are paid, boosting the after-tax returns.
Image source: Getty Images
Start by saving
Investors don't need a lot of money to start investing in ASX shares. You can open a share trading account with as little as $500. However, it could make more sense to invest more than $500 at one time so that the brokerage fee is a smaller percentage of the cost.
Bank accounts are finally offering better interest rates, with good ones offering a rate of more than 3%. While we may want to invest our money as soon as possible, our cash can make a decent return while it builds.
Putting aside $30 a week translates to a yearly total of $1,560. Saving this amount each week may be easy for some people and a task for others. It may involve finding cheaper alternatives for products or services, getting extra income from a part-time job, or whatever it takes.
Begin investing
Investing that $1,560 into an ASX share that pays a 5% dividend yield would make $78 of annual dividends in year one. Picking a share with a dividend yield of 10% would generate $156 of annual dividend income. That's not bad for the start of a second income.
There are some quality blue chips that pay dividend yields of around 5% to 7%, such as Wesfarmers Ltd (ASX: WES), Telstra Group Ltd (ASX: TLS) and Coles Group Ltd (ASX: COL). These are the sorts of names that could do well with a long-term investment strategy.
Investors may consider ASX shares with higher dividend yields than that, but ideally, those names could grow earnings over the long term. Companies with very high dividend yields include Adairs Ltd (ASX: ADH), Shaver Shop Group Ltd (ASX: SSG), Best & Less Group Holdings Ltd (ASX: BST) and Pacific Current Group Ltd (ASX: PAC).
The second income can benefit from compounding
One year of investing is unlikely to unlock all of the passive income that investors are looking for.
Starting off with $75 of annual income after year one is good. Building that to $150 in year two, $225 in year three and so on, by continuing to invest, would build an impressive stream of dividends.
Good businesses tend to keep growing their profit and dividends. If a $100 dividend payment grows by 5% each year because the company increased the dividend, it would be $105 in the second year, $110.25 in the third year, $115.76 in the fourth year and so on.
Investors can benefit from organic dividend growth from their investments, as well as adding more money over time.
The more time we give — and the more money we add — to our investment portfolio, the bigger the dividend cash flow that can be created.
