A second income is the holy grail of investing for many of us. This may be a second income that allows us to plan more family holidays, evenings out, or just make us feel more financially secure.
Owning shares in top-tier companies can build substantial wealth for patient investors. Given sufficient time, high-quality stocks, from blue-chip to small-cap, can deliver big returns that can unlock an impressive income stream.
Even if I, or another investor can only spare £200 a month, it’s enough to potentially create an annual second income stream worth £36,167.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
Investing for the long run
The FTSE 100 and FTSE 250 haven’t performed overly well for the past five-to-eight years. And that’s not been particularly positive for UK-focused investors.
However, looking at the longer picture, we can see that the FTSE 100 has delivered annualised returns around 7% over the last 30 years. In the case of the FTSE 250, that figure is around 10%.
Of course, US stocks have outperformed UK-listed stocks hugely. In fact, the tech-heavy Nasdaq is up 108% over the last five years alone — the FTSE 100 and FTSE 250 have stood still.
Nonetheless, by setting out to invest for the long run I can iron out bumps in the market. And by building a diversified portfolio, I should be more insulated from sector- or market-specific issues.
Below, we can see how much money I’d have after certain periods if I were to invest £200 a month in index trackers.
| FTSE 100 | FTSE 250 | NASDAQ (c.12%) | |
| 10 years | £34,616 | £40,969 | £46,007 |
| 20 years | £104,185 | £151,873 | £197,851 |
| 30 years | £243,994 | £452,097 | £698,992 |
Needless to say, the difference between 7% and 12% over the long run is phenomenal. But while it may be tempting to put all my money in a Nasdaq tracker, it’s probably wiser to make selective investments in several industries and stock markets.
Beware of risks
Investing in stocks is by no means risk-free, and just because the index goes up, doesn’t mean those I’ve invested in will go up too.
In fact, novice investors often lose money, making emotive or poorly thought-out investment decisions. Thankfully, these days there’s a wealth of information out there to help us make sensible investment decisions.
As such, I’d take a strategic approach and rely heavily on data to help me make investment decisions. This can be easier than it sounds.
Thankfully, there are many platforms where I can find useful metrics. These include the price-to-earnings ratio, price-to-earnings-to-growth ratio, and discounted cash flow model.
And while a data-driven approach doesn’t insulate me from market fluctations, it can certainly help me pick more winners than losers.
The bottom line
Let’s imagine I invest in a diversified portfolio of stocks, some happen to be listed on the FTSE 100, some on the FTSE 250, and others on the Nasdaq or another international exchange.
After 30 years of investing, I could have £452,097 — assuming 10% annualised returns. And with that, I could generate £36,167 annually as a second income by investing in dividend stocks — 8% is probably the best average yield I could hope for.
It’s not risk-free, but it’s worked for millions of investors.
