We’d all love a second income. Whether that’s a little something to help with our bills like paying the rent, other whether it’s money we set aside for family holidays, it certainly helps to have another income source.
Right now, with interest rates at their highest in decades and some excellent yields on the FTSE 350, as investors, we’re presented with a host of opportunities to generate passive income.
Generating passive income
I appreciate interest rates are pretty handsome right now for savers. But I’m confident I can achieve better returns by investing in stocks and the occasional fund.
Today I’m looking at what could be possible with £5,000. In fact, the average ISA market value at the end of 2019 to 2020 was around £3,910 for Britons under 25 and £6,366 for the 25 to 34 age group. So, for illustrative purposes, £5,000 is good starting point.
But with £5,000, even invested in some of the biggest yielding dividend stocks on the FTSE 100, I could only look to achieve around £400 a year.
So, how can I transform this pot into something much larger that can generate 10 times the above in passive income every year?
Let’s take a look.
Investing in dividends
Nothing is guaranteed when investing. That’s especially the case when making speculative investments in growth stocks. Many novice investors are drawn in by the possibility of making quick money. Some people were fortunate during the pandemic, but many, many more have had their fingers burnt.
Instead, I prefer to use a slow and steady strategy, revolving around dividend stocks — notably ones with higher yields.
Of course, it pays to be wary of big dividend yields. I need to do my research to understand whether the yields in question are sustainable.
I tend to start with the dividend coverage ratio — anything above two is healthy, but I don’t discount firms with lower ratios. Strong cash flow is another important characteristic of a safe dividend.
To generate £4,000 a year as a second income, I’m going to need £50,000. That’s because I think 8% — at least at the moment — is the highest achievable yield without sacrificing the sustainability of the dividends.
How it’s done
I’m using a compound returns strategy. This means I’m going to reinvest the dividends I receive every year. But I’m also going to make monthly contributions.
So, when starting with £5,000, investing in stocks with an average 8% yield, and then contributing £200 a month, while increasing this contribution by 5% a year, it’d take me 9.5 years to reach £50,000.
With this £50,000, I could keep my money in stocks with 8% yields and I’d receive £4,000 a year in passive income.
Right now, these 8% stocks include companies like Phoenix Group, Legal & General, and Aviva — all giants of the insurance industry.
