£10K in savings? I could turn that into a second income worth £5,548!

Our writer explains how dreams of a second income can become a reality with a thought-out plan involving investing in stocks.

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Away from my day job, it would be great to create a second income stream. I reckon it’s entirely possible to do this by investing in dividend-paying stocks.

Let me explain how I’d do that if I had a £10K lump sum to start with.

Diversification and maximum returns

Let me start by making it clear that dividends are never guaranteed. I’d need to buy the best stocks with prospects of consistent and above-average returns, as well as solid fundamentals.

In addition to this, I’d look to ensure I have a diverse set of stocks as diversification can help mitigate risk.

As my investment mode, I’d opt for a Stocks and Shares ISA. This is because I don’t need to pay a penny of tax in dividends.

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.

I’m going to let the magic of compounding help me maximise my pot.

With my initial £10K lump sum, I’m also going to add £100 per month. For me, that’s sacrificing a few takeaway meals a month. As for my plan, I’m aiming for a return of 7%. After 20 years, I’d be left with £92,480.

Now, I’m going to draw down 6%, which leaves me with an additional income of £5,548 annually to enjoy.

I could start drawing down money sooner, but I’d be left with less of a pot. Personally, I’d let my pot build up, and then draw it down later in life. Hopefully by this point I won’t have major expenses such as a mortgage left to pay. In turn, I can spending this extra money on whatever my heart desires.

Banking giant

As a good example of the type of stock I’d buy as part of this plan, Lloyds (LSE: LLOY) is a good option, in my view.

Firstly, this gives me access to the banking sector. Second, Lloyds has some attractive traits, as well as passive income prospects that could help me maximise my pot of money.

From a bullish view, Lloyds is the largest mortgage provider in the UK, and is a vital cog in the UK banking ecosystem. The current housing crisis in the UK – whereby demand is outstripping supply – could present a great opportunity for the market leader to capitalise for years to come and boost earnings and investor returns.

At present, the shares offer a dividend yield of close to 5%. Furthermore, the shares look great value for money on a price-to-earnings ratio of just seven.

On the other side of the coin, there are a couple of issues that could hurt Lloyds’ earnings and returns. Firstly, higher interest rates at present have made mortgages harder to obtain, which has resulted in a slowdown in performance. This cyclical nature of the business isn’t ideal, but something I’d have to contend with.

The other issue is Lloyds lack of international exposure, like many of its counterparts in the banking industry. It is heavily reliant on UK exposure and business.

For me, the pros outweigh the cons, and the passive income opportunity looks excellent. Lloyds is the type of stock that could help me build the additional income I’m yearning for.

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.

Sumayya Mansoor has no position in any of the shares mentioned. The Motley Fool UK has recommended Lloyds Banking Group 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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