Aiming for a second income is a sensible choice that many are making. It’s not to say that the primary source of income isn’t important. But having a second source of funds, ideally in a passive way, can provide extra liquidity to help us save and build for future financial goals. Here’s what I’d do to build up such an income from the stock market.
Two key steps
To begin with, I need to identify how the stock market can generate regular income. It sounds obvious, but simply buying a stock and holding it for 10 years isn’t going to be the right strategy here.
There are two main ways of making it happen. Firstly, dividends from income stocks. Typically, a business pays out some form of dividend to shareholders twice a year. In some cases, it’s every quarter and the dates vary between companies.
So by owning a selection of stocks that pay out over the course of a year, an investor could build up a just-about-monthly stream of payments over time.
The second way is to ‘trim profits’ from the capital appreciation of stocks that have gone up in value. For example, if £1,000 is invested in a stock and the value rises to £1,100, an investor could sell £100 worth of the stock. This leaves the original amount in play, but banks £100 as income.
Risks to be aware of
The risk with dividend income is that it isn’t guaranteed. Especially when planning years in advance, it can be hard to say with certainty how a business will be performing at that point in time.
As for trimming profits, the assumption is that the stocks owned have appreciated in value. If we have a stock market crash, income could run dry if the portfolio isn’t performing well.
Building up to £500 monthly
Yet in general, the theory checks out. So how does one go about hitting the £500 a month figure? One way is by investing a set amount each month or each quarter.
For example, let’s assume an investor puts away £250 each month into a mix of stocks. I’m going to assume an annual yield of 7% on the portfolio. This is, of course, an estimate but it’s a reasonable one taking into account both the dividends received and potential capital appreciation.
Leaving the money to grow and reinvesting the dividends promptly allows this pot to compound at a faster pace. After 16 years, an investor would reach the target and then be able to enjoy £500 in monthly income from then on.
To speed up this pace, a higher monthly amount could be invested. At a push, investing £500 a month would knock six years off the previous timeframe.
Granted, forecasting into the future is an uncertain art, but by following a sound investment strategy, I’m reasonably confident of generating good passive income.
