£20,000 in savings? Here’s how I’d try to turn that into a £10,739 second income every year!

Generating a sizeable second income can be done from relatively small investments in high-yielding stocks if the dividends are reinvested.

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In my view, money is all about freedom, and generating a second income is a key step towards that.

The best way I have found of generating this is by investing in high-quality stocks that pay high dividends. 

And one of my earliest investments – Legal & General (LSE: LGEN) – still contributes to a high second income for me.

High returns

There are risks in all stocks, of course, and for this investment firm, one remains a new global financial crisis. Another is that its debt-to-equity ratio of 3.8 is higher than the 2.5 or so considered healthy for such firms.

However, for high dividends to be sustainable over time, earnings and profits need to grow.

In Legal & General’s case, consensus analysts’ estimates are that earnings will rise by 23% a year to end-2026. Forecasts are that earnings per share will grow by 24% a year to that point.

The company remains a top player in the UK Pension Risk Transfer (PRT) market, which should act as a powerful engine for growth. In this market, firms pay a specialist company to run their pension schemes.

It is also a top 10 provider in the lucrative US PRT sector, which has huge growth potential. Around $3trn of these pension schemes have yet to be transferred.

Big second income generator

In 2023, Legal & General increased its dividend by 5% — to 20.34p. On the current £2.36 share price, this gives a yield of 8.6%. This makes it one of the very few firms in the leading FTSE 100 index that pays a yield of 8%+.

There are two ways of handling dividends paid every year.

First, they can be withdrawn from the investment account in which they are held and then spent. On this basis, £10,000-worth of shares in Legal & General paying 8.6%, would make £860 a year.

Over 10 years, provided the yield averaged 8.6%, this would add £8,600 to the £10,000 initial investment.

The second way to handle these dividends involves reinvesting them back into the stock. This is ‘dividend compounding’, and it produces much bigger returns than the first option.

Doing this, £10,000 invested at an 8.6% average yield would make an additional £13,559 rather than £8,600 after 10 years.

After 30 years based on the same average yield, the total investment would be worth £130,763. This would pay £10,739 a year, or £895 a month in second income.

Bigger returns starting from £0 in the bank

Would-be investors can achieve the same or more from having £0 in the bank.

Saving and investing just £5 a day in 8.6%-yielding Legal & General shares would produce £28,583 after 10 years. This is also provided that the dividends are reinvested back into the stock.

After 30 years on the same basis, the total would be £254,571. This would pay £20,838 a year, or £1,737 every month in dividend payments!

Inflation would reduce the buying power of the income, and there would be tax implications according to individual circumstances.

However, it highlights that a big second income can come from relatively small investments in the right stocks if the dividends are reinvested.

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.

Simon Watkins 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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