Do you want to know one of the biggest money-making secrets of self-made millionaires? They make their money work for them.
They save and invest all of their spare cash until their assets provide them with an income that’s enough to support their lifestyle.
This may seem an impossible dream for most of us. But the good news is that you can use the same approach to build a second income stream to help fund your retirement. Assuming a long-term stock market average return of 7% per year, investing just £25 per month could leave you with £12,298 after 20 years
Here’s what I’d do to get started.
1. Build a cash shield
How easy do you think it would be to sell a house for cash next week? I suspect you’d find it very difficult, unless you were prepared to accept a knock-down price.
It’s the same with stock market investments. Although stocks and shares are usually easier to sell at short notice, you run the risk of being forced to sell during a market dip, when prices have fallen. This can wipe out years of gains and cause you to lose your hard-earned second income.
That’s why the first step I’d take towards building a second income is to build a cash emergency fund. I’d aim to have enough to live on for at least three months, preferably six.
This cash reserve should help to protect your investments and enable you to ride out short-term problems.
2. Make the FTSE 100 work for you
It goes without saying that you should pay off any high interest credit card debt or loans before you start investing.
But if you’re on top of any debt, then the next thing I’d do is to start investing in a FTSE 100 tracker fund. These are simple, low-cost funds which track the movements of the FTSE 100 index of the UK’s largest listed companies.
This may sound dull, but the FTSE 100 currently pays a dividend yield of 4.6%. That’s more than three times the 1.45% interest rate currently available on best buy cash ISAs. Although dividend payments aren’t guaranteed and can fall, over the long term they tend to rise, at least in line with inflation.
Many tracker fund providers now allow you to invest as little as £25 per month. Costs are low and this is probably the cheapest way to invest in the stock market. When you’re building your investments, you can choose to have your dividends automatically reinvested, boosting the value of your fund.
Once you’re ready to start withdrawing an income, you can opt for dividends to be paid out. You’ll then receive a cash payment in your bank account, usually twice a year.
3. Want more? Consider buying stocks
Following steps one and two is enough to put you on the road to building a second income. But if you have a little more cash available and are willing to invest in individual shares, then I believe you should be able to earn a higher yield from the FTSE 100.
Firms such as BP, Royal Dutch Shell, Imperial Brands (formerly Imperial Tobacco) and Legal & General all offer yields of between 6% and 8% at the moment. In my view these payouts all look fairly safe. I’d certainly consider finding room for some of them in my portfolio.
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Roland Head owns shares of Imperial Brands. The Motley Fool UK has recommended Imperial Brands. 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.