Investing in companies listed on the London Stock Exchange is a brilliant way to generate a second income as they pay some of the most generous dividends in the world.
Buying individual stocks instead of a tracker fund can up the ante. Instead of getting the average FTSE 100 average yield of around 3.6%, I can find stocks yielding 5%, 6%, 7%, 8% and in some rare cases even more.
It’s more than possible for an ordinary private investor to generate passive income of £500 a month from their portfolio. However, unless they have a huge lump sum to start off with, it won’t happen overnight.
Setting myself a target
Investing takes time. For most of us, it involves putting lump sums and regular monthly amounts into the market over months, years and decades.
I basically invest whatever I can, whenever I can, and have no intention of raiding my capital at any time, except in an unforeseen emergency. Today, I reinvest all my dividends back right back into my portfolio to turbo-charge my returns. I’ll only start drawing them when I need them as income in retirement
When investing over such a lengthy period, it helps to have a target in mind. Ideally, it should realistic and achievable, because that’ll make it a lot easier to stay the course.
Income of £500 a month adds up to £6,000 a year. How much capital I need to generate that would depend on the average yield across my portfolio.
If I matched the FTSE 100 average of 3.6%, for example, I would need £166,667 to hit my income target.
That may seem a tall order but isn’t impossible. A 25-year-old who started investing £75 a month, and increased their contribution by 5% a year, would have £379,683 by age 67. This assumes they generate the long-term FTSE 100 average return of 8% a year, with all dividends reinvested.
A 35-year-old who did the same would have £225,897 by age 67. Both would smash my target, unless their portfolios badly underperformed (which is always a risk). My figures are pretty crude but they prove a point.
Obviously, the more I save towards retirement, the merrier my final years are likely to be. But I could generate income of £500 a year with a smaller portfolio.
Important to spread risk
If I targeted stocks paying a higher level of income and they gave me an average yield of 5% a year, I’d get there with a portfolio of £120,000.
Sounds tough? I don’t think so. I recently bought wealth manager M&G, and it yields a blockbuster 9.66%. While ultra-high yields like that one can prove unsustainable, I think there’s a fair chance it will come through.
I’d say the same about Legal & General Group, which yields 8.55%. Utility National Grid yields 5.42% a year. It’s one of the lowest-risk stocks on the index.
As ever with investing, there are no guarantees. Dividends can be cut, stocks can crash. I’d invest in a minimum of dozen stocks so if one or two disappoint, others will hopefully compensate.
Best of all, my second income should steadily rise over as companies look to increase the dividend payouts year after year. In time it could be give me a lot more than £500 a month.