How I’d try to turn £10,000 of Lloyds shares into a second income of £810 a year

Within five years I’d hope to turn a £10,000 investment in Lloyds (LSE:LLOY) shares into an annual second income of £810. This implies a yield of 8.1%, which is far higher than the 3.2% I’d earn by depositing the same amount in one of the bank’s instant access savings accounts.

I think now would be a good time to make the purchase. The bank’s shares are currently trading at around 44p. This is 19% below their 52-week high of 54.3p, which was achieved in February 2023.

The struggling share price means my £10,000 would go further than before. Ignoring fees, I could buy approximately 22,727 shares today.

Some maths

AJ Bell is expecting Lloyds to pay a dividend of 2.7p in 2023. This would be a 12.5% improvement on last year’s figure.

Some are forecasting that next year’s payout could be as high as 3.1p. But I’m going to be cautious and assume that I’d receive the lower of these two figures during each of the next five years.

I’d also reinvest the dividends and buy more shares at the end of each year. That way I could buy an additional 7,259 of them.

For the purposes of this exercise, I’ll assume that the share price will increase by 2.5% annually.

At the end of the five years, I’d own 29,986 shares potentially giving me a second income of £810 per year. The yield on my initial investment would be twice the current FTSE 100 average.

As an added bonus, the value of my shareholding would’ve grown to £14,927.

Caution

This sounds great in theory. But because earnings can be volatile, dividends are never guaranteed.

And the performance of Lloyds is heavily dependent on the UK economy. The bank generates nearly all of its revenue here, and has a 20% share of the mortgage market.

Unfortunately, the domestic economy has performed badly over the past five years. And this is reflected in the bank’s erratic dividends and share price.

To combat inflation, the Bank of England has increased interest rates rapidly over the past two years. The problem is that although this helps Lloyds’ earnings, there’s an increasing risk that customers will default on their loans, potentially wiping out any gain from the margin improvement.

Encouragingly, the Office for Budget Responsibility is forecasting economic growth to return to historical norms from next year. The threat of bad loans should then recede.

What I’d do

I already own shares in Lloyds. And because I believe in the benefits of a diversified portfolio, I wouldn’t want to buy any more. In my view, having significant exposure to one particular stock or sector isn’t a good idea.

However, although the lacklustre share price performance continues to disappoint me, I remain hopeful that it’ll soon start to pick up in line with forecasts for the UK economy.

And I don’t think I’m alone in sharing this assessment. Last week, of all the ‘buy’ transactions on the Hargreaves Lansdown trading platform, over 10% were for shares in the bank.

But irrespective of what happens with the stock price, I’ll continue to reinvest the dividends helping to give me a bigger second income for when I retire.