Interested in a second income stream? Here’s how I would build one

Rupert Hargreaves lays out his top tips for building a second income stream with investments.

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Do you want to build a second income stream? Of course you do. By having a second income stream you can quit the rat race and pursue your dreams without having to worry about working to pay the bills.

In this article, I’m going to explain how I would build that second income stream from stocks and use this income stream to retire comfortably.

Setting the target

The first step is to work out how much income you need. This will vary from person to person. But for this article, I’m going to use the UK’s current median weekly wage of £569, or £29,598 a year, according to the Office for National Statistics. For simplicity, I’m going to round the number up to £30,000 a year. Assuming a 4% yield, I calculate you will need a starting pot of £750,000 to achieve this level of passive income.

For investors just starting on their second income journey, this goal might be a bit unrealistic. So, I’ve tailored the advice below in a way that’s suitable for investors of all experiences and levels of wealth. 

No matter how much money you have to start with, the template below can help you achieve a second income.

Building the pot

As we’re trying to achieve a steady, predictable income stream, I think it’s best to pick blue-chip dividend stocks, companies like Royal Dutch Shell, BP, HSBC, and British American Tobacco. Also, I think a simple FTSE 100 tracker fund will complement this selection of blue-chips perfectly. Together, these slow and steady income stocks should produce a yield on your investment of between 4.5% and 6%.

If you want to build a steady income stream for life, equities are by far the best way because company dividends are usually increased every year. This means your income will rise steadily with inflation, so the purchasing power of your money will be preserved.

I also think if you’re looking to build a second income stream, a small percentage of your portfolio should be in bonds. Bonds don’t have the same attractive qualities as equities, but when it comes to predictable income, they’re unrivalled. If you use a low-cost bond fund get access to this asset class, today you can get a yield of between 3% and 5% on your money.

Lastly, I would recommend including a small number of mid-cap stocks in your income portfolio. 

I think it’s always important to have some mid-caps in a portfolio because they generally have a much higher potential for dividend increases and capital growth. The average dividend yield from these investments is usually lower, but dividend growth over the long term more than offsets the low initial yield. You can probably get a dividend yield of between 2% and 3% without taking on too much risk.

Asset allocation 

When combined, blue-chip stocks, bonds and mid-caps can give you a hands-free income for life. 

Personally, I use an allocation of 70% towards dividend-paying blue chips, 20% towards bonds and 10% towards growth stocks. I calculate this gives me an annual yield on my money of 4.6% from a portfolio that should continue to generate returns in all environments. 

That’s the strategy I recommend if you are interested in building a second income stream.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Rupert Hargreaves owns shares in Royal Dutch Shell and British American Tobacco. The Motley Fool UK has recommended HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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