The stock market can be a great place to turn excess savings into a second income. And the best bit about being an investor is that it doesn’t involve any work.
According to the Pensions and Lifetime Savings Association, a single person needs just over £43,00 a year to retire comfortably. But is a mighty £500,000 savings pot enough to generate that kind of cash?
Dividends
Right now, the FTSE 100 as a whole has a dividend yield of 3.5%, so a £500,000 investment today would return £17,500. That’s not enough to generate a £43,000 second income – at least, not yet.
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An investment in UK stocks, however, has potential to grow. Over the last 20 years or so, the FTSE 100 has generated an average annual return of 6.89%.
That level of return isn’t guaranteed to continue in future. But if things continue as they have done, someone who has managed to assemble £500,000 in cash (admittedly, no easy task) could be generating £43,000 per year within 14 years.
To aim for better results, though, investors might look to be more selective about where they invest. And there are a couple of strategies for doing this.
Phoenix Group
One approach involves looking for stocks that have higher yields. With a 9% dividen yield, Phoenix Group (LSE:PHNX) is one that might be worth considering.
The firm operates in the pensions and insurance industry, which can be risky. With annuities, future returns are always uncertain due to interest rates and increasing life expectancy.
Investors should note, though, that Phoenix Group just reported 31% growth in operating profits. And it’s expecting to generate £5.1bn over the next three years.
That’s almost the company’s entire market cap. So I think it’s certainly worth thinking about whether the current share price overestimates the risks inherent with the business.
Bunzl
A very different type of stock is Bunzl (LSE:BNZL). The current dividend yield is just 2.5% but I’ve recently bought it for my own portfolio and I think it’s worth considering at today’s prices.
The firm is aiming to deploy £700m – around 7.2% of its current market value – per year into growth and shareholder returns. I’m expecting this to result in higher dividends over time.
A lot of Bunzl’s growth has come through buying other businesses, which means there’s always a danger of overpaying. That’s the biggest long-term risk with the stock, as I see it right now.
Management, however, thinks the current opportunity set is encouraging. And the chance to repurchase shares if targets don’t emerge means investors aren’t just relying on acquisitions.
A ‘comfortable’ retirement
It goes without saying that anyone with £500,000 should think carefully before deciding what to do with it. But in my theoretical scenario, the the 9% dividend yield from Phoenix shows that it’s strictly enough to earn a £43,000 second income. That’s worth thinking about for those of us building our portfolios over time.
There is, however, something else investors should think about. While £43,000 per year might be what someone needs for a comfortable retirement, a portfolio with only one stock in it might well make someone feel anything but relaxed.
I think being genuinely comfortable involves building a diversified portfolio of shares. And combining dividend shares with growth stocks looks like an attractive plan to me.
