£11,000 of savings? Here’s how I’d aim for a second income worth £12,560 annually

For many of us, a second income is the holy grail of investing. Dr James Fox explains how he’d kick things off and aim for a substantial income.

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Lots of us invest to earn a second income and support our lives accordingly. However, it can also feel unobtainable for some of us, especially if we’re not starting with a huge amount of capital.

So how can I turn £11,000 into a sizeable second income?

Creating a strategy

Opening a Stocks and Shares ISA is a smart first step. It’s essentially a wrapper that shields my investment from capital gains and income tax. This means when I come to take a second income, it’ll be tax-free.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

It also means my investments can grow at a fastest pace. Because if I’m started with a relatively small amount of capital, I need my investments to grow and compound.

I can also help my portfolio grow faster by making regular contributions. Even as little as £100 a month can significantly enhance the compounding effect, accelerating the growth of wealth over time.

Harnessing the power of compounding

The power of compounding is the true magic in wealth-building. By consistently reinvesting my earnings, each investment and its subsequent returns fuel a cycle of exponential growth.

As returns accumulate, they generate more returns, transforming the initial £11,000 and subsequent contributions into a snowball effect of increasing wealth.

Here’s an example, using an annualised return of 10% and £100 of monthly contributions. As we can see, the speed of growth appears to increase over time. That’s because I’m earning interest on my interest.

Created at thecalculatorsite.com

After 20 years, I’d have £157k. That’s enough to generate £12,560 a year in passive income, assuming a dividend yield of 8% can be achieved.

Investing wisely

However, if I invest poorly, I’m going to lose money. It’s great to have a strategy where everything works out on paper, but I need to make wise investment decisions. So where should I put my money?

Well, my strategy revolves around finding companies with under-appreciated growth potential. One such company is AppLovin (NASDAQ:APP). It’s a technology firm that helps app and website developers and operators maximise advertising revenue.

The business hasn’t had the smoothest growth trajectory in recent years, and that does represent a risk. But the company appears to have turned a corner. In fact, it’s currently trading at 13.8 times forward earnings and has a price-to-earnings-to-growth (PEG) ratio of 0.69.

This PEG ratio suggests the company is significantly undervalued, driven by the success of its AXON 2 software. It’s also undertaking a shift towards the high-margin software segment, given the maturity of the app business. And this appears to be paying dividends, allowing for more stable growth versus historic averages and margin expansion.

Moreover, I appreciate some investors may be wary of a stock that’s up 381% over the past year. But momentum’s actually a great indicator of future performance. Equally, the growth has been driven by earnings beats. That’s a great sign.

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 AppLovin. 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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