Here’s how I’d aim to double my second income!

For many of us, investing is a way to earn a second income, and it can be one of the most effective and time-efficient ways to do so.

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Investing is one of the simplest ways to earn a second income. It doesn’t require me to take a second job or anything like that. It’s simply about investing in stocks for a solid and stable return. The issue for many of us is the fact that we need a lot of money to generate a significant passive income.

In short, the best dividend yield I could look to achieve when investing in a basket of stocks is around 8%. So, even with £50,000 invested, I’d only be earning around £4,000 a year as a second income.

How to double it

If I were looking to double my second income through investing, there are several things to bear in mind.

Firstly, dividend payments from well-run companies often increase. That means if a company continues to raise its dividend payments, my dividend yield will increase in turn.

So, if I pay £1 for a share with an 8p dividend which increases at 10% a year, it’d take seven years for that dividend payment to reach 16p. In other words, this means my dividend yield will have gone from 8% to 16%.

As such, it can certainly pay me to research companies with stable dividends and a history of increasing the dividend payments year on year.

Take this example. Legendary investor Warren Buffett invested $1.3bn in the Coca-Cola shares 30 years ago in 1994. And today, he receives $736m annually in dividends from the investment. That’s a dividend yield in excess of 50%.

I could also combine this with a compound interest strategy and regular contributions. In other words, by reinvesting my dividends year after year and contributing a little of my salary every month, I could double my second income much sooner.

Investing right

If I invest poorly, I could lose money, and therefore, doing my research is really important. In this scenario, I should be looking for a Dividend Aristocrat. This is usually defined as a company that has consistently increased its dividend payments every year for at least 25 years, but given the pandemic and the 2008 financial crisis, there aren’t many of them.

Legal & General (LSE:LGEN) almost fits the description. The dividend payment has expanded from 16.42p in 2018 to 19.37p in 2022. This currently represents an 8.27% dividend yield, making it one of the strongest on the FTSE 100.

The dividend payment roughly grew 5% annually over the period listed above. So, if that were to continue, the payment would reach 30.4p within nine years. In turn, this would be a 13% dividend yield based on the price I’m paying for the stock today.

However, if we factor in some reinvestment — in other words, I have my dividend reinvested each year — I think we could easily be looking at returns that are double the current 8.27% within five or six years. It’s not a perfect science as there are so many moving parts, but it does work.

I appreciate UK insurers don’t have the best records for share price growth. The stock is actually down 10% over five years, broadly mirroring the underperformance of the FTSE 100. However, I’m buoyed by a fair dividend coverage ratio of 1.98 and the strong cash flows the sector generates.

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 Legal & General Group 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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