£25k to invest? Here’s how I’d try to turn that into a second income of £12,578 a year!

If Harvey Jones had a lump sum to invest today he’d go flat out buying top FTSE 100 second income stocks to build a comfortable retirement.

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When I retire, I’m planning to top up my State Pension by generating a second income from top dividend stocks. 

If I had a £25,000 lump sum to invest today, I wouldn’t hang around. I’d spend the summer looking for FTSE 100 shares that can potentially deliver a high and rising passive income stream all the way to retirement and beyond.

Today, I’d reinvest all my dividends straight back into the same stock, to help my money compound and grow. Then I’d look to draw them as income after I retired.

FTSE 100 high yields

I wouldn’t throw my £25k into the market in one go. I’d feel a bit miffed if the stock market crashed the next day. I wouldn’t leave it too long, though. I want my money invested rather than sitting on the sidelines. Otherwise I’d risk missing out on the dividends and growth the market does deliver. I’d look to invest in five chunks of £5k, across five different shares to spread my risk.

I’d start by looking for a stock with a strong track record of delivering both a rising dividend and share price growth. Distribution group Diploma (LSE: DPLM)), which supplies technical products and services to companies in North America and Europe, scores well on that front. Its shares are up 39.3% over one year and a thumping 158.04% over five.

While the yield doesn’t look spectacular at 1.43%, that’s largely a consequence of its rocketing share price. Diploma has a stellar track record of dividend growth lately. Let’s see what the chart says.

Chart by TradingView

It has hiked shareholder payouts at an average rate of 13.7% a year for a decade, AJ Bell figures show. It’s now on course to hike its annual payout for the 24th consecutive year. This is a true Dividend Aristocrat. In the last decade, Diploma has delivered a total annual total return of 620.2%, with all dividends reinvested.

Top dividend growth stocks

It isn’t cheap. Today, its shares trade at 33.09 times earnings. Another concern is that the US economy is slowing, which could hit sales.

But the £5.5bn group is still growing, helped by a successful acquisition strategy, and recently posted a 17% rise in adjusted half-year earnings. If markets dip over the summer and that valuation eases, I’ll consider buying it.

I might balance Diploma with a few higher-yielders, like insurer Aviva, which currently pays income of 6.96% a year, and housebuilder Taylor Wimpey, which yields 6.65%.

Let’s say my stock picks yielded an average of 5% a year and grew at an annual compound rate of 8%, with all dividends reinvested. After 30 years, my £25k would be worth £251,566. That’s not a bad return. If my portfolio still yielded 5%, that would give me income of £12,578 a year.

With luck, that would continue to grow, as companies increased their dividends, while my capital would still be sitting there.

Building enough money to generate a decent-sized second income takes years. That’s why I’d aim to get started as early as I could. No time to lose!

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.

Harvey Jones has positions in Taylor Wimpey Plc. The Motley Fool UK has recommended Aj Bell Plc. 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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