£2,500 in savings? Here’s how I’d aim to turn that into an £27,113 second income

Many of us have savings, or put an amount aside every month. But it’s what we do with it that counts. Dr James Fox explains his second income plan.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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Ask 100 people why they invest, and more than half will talk about a second income, whether that’s to be taken today or at some point in the future.

However, on average, Britons save roughly £105 a month — a figure that varies significantly depending on an individual’s income.

As such, it’s unsurprising that many of us don’t have a huge amount of money set aside.

So if I was starting with £2,500 in savings, I’ve got to be realistic. There’s no way I can expect to generate a life-changing second income in the near term.

Even with all that money invested in Phoenix Group, which pays an index-topping 10.5% dividend yield, I’d only be earning £262.5 annually.

Getting richer

So if I’m aiming for a life-changing second income, the first step is to build some funds.

There are three parts to my strategy:

  1. Investing: Savings accounts offer meagre returns, even today despite interest rates being higher than they’ve been for decades. While my HSBC savers account offers me 2% AER, I aim for double-digit returns on my investments.
  2. Keep on contributing: It goes without saying that the more I contribute, the easier it is to grow my portfolio. It’s like providing more fuel to the fire, and even £105 a month could make a huge difference over the long run.
  3. Reinvesting: It’s something we Fools write about a lot. Reinvesting allows for compounding, leading to exponential growth over time.

Compounding

If I start with £2,500, contribute £105 a month, and place it in my HSBC savings account with 2% AER, after a year I’d have £3,822. Total interested earned: £62.

However, if I start with £2,500, contribute £105 a month and invest it, targeting a 10% annual return, after a year I’d have £4,081. Total interested earned: £321.

There’s a clear advantage to the investing route here, although I must recognise investing isn’t risk-free.

But the real benefit of the investing route comes over the long run, and when I harness the power of compound returns.

That’s because when I reinvest, I’m creating an ever-expanding base from which I can earn even more interest.

Here’s what happens when I continue the earlier examples over a 30-year period. Figure 1 shows my savings growing at 2%, while Figure 2 shows my investments growing at 10%.

Figure 1: Created at thecalculatorsite.com
Figure 2: Created at thecalculatorsite.com

My take

After 30 years, in example one, I’d have £56,289, and on the 30th year it’d generate a second income worth £1,100. Meanwhile, at the end of example two, I’d have £289,944, which would generate £27,113 in the final year.

Is there a catch? Well, it’s all about risk. There’s practically no risk involved in leaving my money in a savings account.

However, if I invest poorly, I could lose money, and losses can compound. That’s why I need to research my investments and take advantage of democratising platforms such as The Motley Fool.

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.

James Fox has positions in Phoenix Group Holdings plc. The Motley Fool UK has no position in any of the shares mentioned. 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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