Using stocks to earn a second income is a popular way to fund a more luxurious retirement lifestyle. But it’s no secret that when following the 4% withdrawal rule, investment portfolios need to be worth a considerable sum to provide a meaningful income stream of, say, £30,000.
Fortunately, building a chunky nest egg is relatively straightforward, thanks to compounding returns. And for those fortunate enough to already have £50,000 saved up, the timeline isn’t as long as many might think.
Aiming for a £30k second income
At 4% a year, a £30k annual income stream would require the underlying investment portfolio to be worth £750,000. That’s obviously not pocket change. But it’s also relatively easy to acquire when combining prudent financial decision-making with patience.
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Let’s start with one of the most popular investing methods – index funds. Since its inception, the FTSE 100’s delivered an average annualised return of around 8%. And while the FTSE 250 has typically offered closer to 11%, it’s also been more volatile. Let’s assume an investor wants to stick with a more conservative strategy.
With £50,000 to invest at an 8% return, how long would it take to reach £750,000? The answer’s around 34 years. Fortunately, a huge chunk of time can be eliminated by simply topping up the portfolio each month. And with just an extra £500 each month, the journey can be shortened by a decade. But what if we wanted to speed things up even further?
Taking on more risk
If investors were earning the FTSE 250’s historical average of 11%, the journey to earning a £30,000 second income could be reduced to just 18 years. Yet this relies on the assumption that the UK’s flagship indexes will continue to deliver their historical returns. And looking at more recent history, that just hasn’t been the case.
In fact, both indexes over the last decade have barely scraped past a 6% average. As such, investors relying on index funds could be waiting considerably longer than expected. And it’s why picking individual stocks could be the more successful strategy.
While the UK stock market hasn’t been as explosive as the US, the London Stock Exchange still has its fair share of growth opportunities. One terrific performer from my portfolio has been Alpha Group International (LSE:ALPH). The currency risk management and alternative banking fintech group has surged almost 230% since my initial investment in 2020. That’s the equivalent of a 34.8% annualised return!
These gains have been driven by an increased demand for its services as volatility flooded the financial markets in the wake of the pandemic. However, a lot of this growth in the foreign exchange markets has started to slow as economic conditions improve. Luckily for Alpha, management had been using its Covid windfall to invest in its alternative banking platform which has carved out a lucrative niche to offset cyclical downturns.
Cyclicality and volatility both remain a notable risk for this enterprise. Yet the cash-generative nature of its business grants management a lot of flexibility, even during the bad times. And while it’s now a member of the FTSE 250, that wasn’t the case a few years ago. In other words, index investors missed out on a terrific growth story.
