There are many different ways to target a large and regular second income. I love the idea of investing in dividend shares and using the income to reinvest to grow my portfolio. Later on, I’m hoping to use income-paying stocks to cover my living costs and luxuries in retirement.
My portfolio consists mainly of quality blue-chip shares from the FTSE 100 and FTSE 250. We’re talking companies with decades-old business models, strong balance sheets, and a sensible approach to paying large and growing dividends over time.
My strategy is no big secret. But it’s one that can generate life-changing passive income down the line.
Getting started
The first question to ask is: how much do you need to invest for a healthy passive income to live on? The truth is, there’s no universal answer to that question.
It depends on what stocks an investor decides to buy, and the returns they generate. It also comes down to the length of time they stay invested — the longer you’re in the market, the more time your pot has to grow.
But let’s use history as an example to get an idea. Let’s say we have someone managing to achieve a 9% typical annual return. That’s bang in the middle of the 8% to 10% long-term average. We’ll assume they do this for 25 years until retirement.
How much monthly income would they have if they invested £20,000 in a Stocks and Shares ISA?
Trebling up
After that 25 year period, they’d have £188,168 sitting in their ISA, and all of it tax free. If it was then invested in 7%-yielding dividend shares, they’d have a yearly second income of £13,172, or just under £1,100 a month.
That’s not a bad bit of money to help cover retirement costs. However, is it a number you’d be happy with? It’s not one I’d be especially thrilled about. With the future of the State Pension becoming increasingly uncertain, I’m personally targeting more than this.
And I’m doing this by steadily drip-feeding money into the stock market. The extra boost this gives to the compounding process can be significant. And here I’ll show you how.
Able to invest a £20k lump sum and an extra £300 a month? Over the same 25 years and with the same 6.79% average return, that nest egg would grow to £524,505. An ISA of this size would then throw off £36,715 worth of dividends a year, or £3,059 a month.
What to invest in?
But what should you buy to target that sort of second income? I love the exceptional returns delivered by HSBC (LSE:HSBA) down the years.
Since 2015, it’s provided — through a mix of capital gains and dividend income — an average annual return of 14.7%. If this continues, this FTSE 100 stock alone could significantly balance out other parts of my portfolio that underperform.
But what are the chances of HSBC shares continuing their stellar run? In my view, they’re extremely strong. It’s why I hold the bank in my own portfolio.
Though it faces rising competition from challenger banks, I’m confident its strategy of pivoting closer to high-growth emerging markets will deliver more stunning returns. And with a strong balance sheet, HSBC has significant cash to invest for growth while continuing to pay market-beating dividends.
