How I’d invest £250 a month in FTSE 250 shares for a second income

FTSE 250 shares are predominantly known for their growth potential. After all, the UK’s second flagship index is home to a diverse collection of younger businesses on their way to joining the ranks of the FTSE 100. But not all of these enterprises are fast movers.

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In fact, there are numerous constituents offering enticing income opportunities for investors. While the index as a whole only has a yield of 3.2%, several stocks currently provide significantly more, with the potential to expand shareholder payouts even further in the future.

Beware of high yields

Today, out of the 250 shares in the FTSE 250, 46 currently offer a dividend yield greater than 6%. And the award for highest payout currently goes to Diversified Energy Company at a whopping 14.9%!

However, a high yield is often a poor way to judge the quality of an income stock. In fact, in many cases, it can be a giant red flag.

Don’t forget dividends are an optional way for companies to return excess capital to shareholders. They’re not guaranteed. And as such, they can be cut or even outright cancelled if there aren’t enough earnings to fund them.

When cash flow gets disrupted, businesses normally fail to meet expectations. And investors typically start exiting their positions, dragging the share price down. But since yield is inversely related to share price, it increases, luring novice investors into a potential trap.

If the disruptions to earnings are severe, dividends will likely be put on the chopping block. And investors expecting a high payout will be left sorely disappointed. That’s why whenever seeing an elevated yield, it’s critical to investigate further.

Investors need to verify if the firm can fund its shareholder payouts and investigate whether any looming threats could compromise payouts in the future. One of the easiest ways to detect the latter is a quick glance at a share price chart. If there’s been a sudden dip in recent months, then something is probably awry.

Finding lucrative income opportunities

Focusing on finding sustainable high-yield stocks is a common approach on the journey to building a second income. But there’s an alternative that can become far more lucrative in the long run.

Instead of looking exclusively at the companies that offer the biggest dividends today, investors can pursue FTSE 250 shares capable of producing higher payouts in the future. Take Safestore Holdings, for example.

The self-storage company has been expanding its real estate empire for over a decade, resulting in a slow but steady rise in earnings. As such, management has been able to increase dividends every year since 2009. The stock currently only offers a yield of 3.2% at the current share price. However, any investor that bought and held onto their shares since 2009 currently enjoys a yield of 51.4%, based on their original purchase price!

That’s why if I had £250 to invest each month, I’d spend my time trying to find the next Safestore rather than jumping straight into bed with the highest dividend-paying FTSE 250 shares today.

The post How I’d invest £250 a month in FTSE 250 shares for a second income appeared first on The Motley Fool UK.

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Safestore 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.