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Having a second income to boost my earnings while I work and top up my pension after I retire is a must for me. Starting early makes it more doable.
My preferred method of building a passive income is by investing in the stock market, and in particular FTSE 100 companies, as they pay some of the most generous dividends in the world.
The lead index is forecast to yield 4.2% this year, while some individual stocks yield 6%, 7%, or more. I recently bought particularly high-yielders M&G, which pays 9.67% a year, and Legal & General Group (8.27%).
No more time to lose
The hardest part of investing is getting started. Someone who has no savings today should get a move on because the longer they invest, the more time their dividends have to compound and grow.
So let’s do some sums and see how much people need to invest each month to hit that income £1,000 monthly target, which works out at £12,000 a year.
Under something called the ‘safe withdrawal rate’, financial advisers reckon that drawing 4% from a portfolio as income each year, the pot will never run dry. So to generate income of £1,000 a month today, I’d need £300,000.
That looks like a daunting target, especially if someone has zero savings. But by investing little and often it starts to look more than doable.
Younger investors have the edge, as time is on their side. At 25, someone who invested £75 a month would have £320,473 by age 67, comfortably beating my target.
My calculations assume that they increase their stake by 3% each year to keep up with inflation and their investments grow at 6.89% a year, which is the average annual return on the FTSE 100 over the last 20 years.
Early birds do better
Someone who has no savings at 35 will have to invest more every month. They still have more than 30 years to retirement though, so shouldn’t despair.
If they invested £175 a month, they would have £338,031 by age 67, using the same assumptions as above. Someone who started investing from scratch at age 45 would have to invest £400 a month to hit the same target, and would have £318,549 at age 67, under my assumptions.
Finally, a 55-year who is just 12 years away from retirement would need to put away £1,250 a month, which would give them £329,245 at 67.
These are not guaranteed returns. Nobody knows how will the stock market will perform. It could deliver more than this, or a lot less. Yet history shows that shares outperform every other asset class in the long run, so that’s how I would aim to build my second income.
The final challenge is that inflation will steadily erode the value of my monthly £1,000 income target, so I’d try to save even more than £300,000.
The next step is to build a portfolio of funds and shares, and Fool.co.uk offers new tips and suggestions every single day. I’d start my search there.