To me, over and above all other factors, the key to making serious second income is to start investing early. The earlier the better as even seemingly insignificant sums saved and invested early can grow into mountains of cash.
Currently, a cup of fancy coffee in much of the UK costs around £5, as does a pint of beer. Cutting out either of these per day would allow an investor to save an incredible-sounding (but true) £1,825 in a year.
This could be invested in three top-flight (FTSE 100) stocks that pay high dividends. Among my current favourites are financial services giant Legal & General, commodities trader Glencore, and ‘Big Four’ bank NatWest.
I already hold the first and the third of these stocks. But I would happily buy the second if I did not already have other holdings in the sector.
The present yields on the three are, respectively, 8.6%, 9%, and 13%, which gives an average of 10.2%.
The power of dividend reinvestment
If this average rate stayed the same, after seven years, an investor would have doubled their money. After 11 years, the initial investment would have tripled.
And after 18 years, the investments would be making over £1,000 per year in second income.
It could be much better than this, though. From the start of the FTSE 100 in 1984 to the end of 2022, its overall price return was 645.2%. This equates to 5.3% on an annualised basis.
If this return was factored into the three-stock portfolio, the investment could be making over £1,000 per year after just 10 years.
And after 27 years, it could be making over £1,000 in second income each and every month.
Beyond this, the gains become even more spectacular, provided the investment and FTSE 100 yields remain in place.
After another 10 years, the total pot would be £282,900. This would provide £37,965 per year in second income, or £3,164 per month!
It is apposite to note here that stocks in this mix can be substituted if their yields start to fall. The same is true if their prices start to drop consistently.
This said, selling a stock that has made a gain over time would incur a tax liability. Inflation as well would have to be factored into the spending power of these returns over time.
A happier retirement prospect
Whether or not the UK’s ‘triple lock’ State Pension will remain in place remains to be seen. In any event, I have always believed that relying on others is not the best way forward.
Currently, the state pays retirees £10,600 per year, or £883 per month. To have a ‘basic’ standard of living in retirement, the government says £13,000 (£1,083 per month) per year is needed.
Clearly, there is already a gap between the State Pension and that basic standard of living.
That gap nearly doubles when looking at the amount required for a ‘moderate’ standard of living — £23,300 per year (£1,942 per month). And to enjoy a ‘comfortable’ standard of living, it is positively gargantuan — £37,300 (£3,108 per month).
However, in the portfolio model, above the returns after 37 years would be more than needed for a comfortable retirement – on their own.