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Here’s a dirt cheap way of creating a second income stream through the stock market

A second source of income is, of course, a great thing to have. Even better if it can be achieved with little effort. Not only can it help in the event of an unexpected period of unemployment, it can also be used to increase your chances of retiring as soon as possible (or even just a few years earlier than the herd).

And the best source of this extra cash? The stock market, of course! The only snag with all this is that equities can be rather volatile. Moreover, the dividends paid by individual companies (which constitute the second income stream) can’t be guaranteed. Indeed, they’re often the first thing to be sacrificed in the event of poor trading.  

Extra cash… on the cheap 

There’s a solution, however. Buy a passive fund that tracks an index and pays a decent yield, thereby generating income for less risk. The fund will still fall in value if the market does, of course, but this shouldn’t matter if you’re investing for decades rather than months. 

So, what options are available? The first that springs to mind would be a bog-standard exchange-traded fund that mimics the FTSE 100. Thanks to ongoing concerns over Brexit, the top tier is still 13% lower than where it stood back in May last year, meaning that you’ll be getting considerably more bang for your buck. 

Remember, however, that our primary objective here is generating an income stream.

Buying the iShares Core FTSE 100 ETF and you’ll secure a 4.39% yield — far more than the 1.45% interest promised by the best easy access cash ISA. And if that isn’t good enough for you, there are other options.

US index fund giant Vanguard (whose founder John Bogle sadly passed away this month) offers the FTSE UK Equity Income fund. As it sounds, this tracks the FTSE UK Equity Index and invests in 127 stocks, including giants such as Astrazeneca, Unilever, BP and HSBC.

The fund yielded 5.71% at the end of 2018. There’s no guarantee of receiving this amount, of course, since payouts depend on what happens in the index. 

The iShares UK Dividend fund is also worthy of consideration. It offers a better yield (6.49%) than Vanguard but at a slightly higher risk by investing in a smaller pool of stocks (50) offering only the biggest dividends.

A bonus to holding any of these funds are the low fees they charge, relative to actively managed ones. The iShares UK Dividend fund has an ongoing charge of 0.4%, Vanguard’s charges 0.22%, and the Core FTSE 100 ETF has a total expense ratio of just 0.07%.

Since everything is being decided by a computer rather than an expensive fund manager, you can be assured that you’re not throwing money away needlessly. In the day-to-day frenzy of the markets, it’s often forgotten that reducing what you pay to as little as possible can be just as important as what you buy. 

What then?

Having purchased one or some of these funds, you then need to do as little as possible, aside from making regular payments into your Stocks and Shares ISA, or SIPP (Self-Invested Personal Pension). That’s right — sit back, resist meddling, re-invest what you receive (if possible) and let the power of compounding take over.

In time, there’s no reason why this second source of income can’t become the only one you actually need.

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Paul Summers has no position in any of the shares mentioned. 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.