Building a second income doesn’t involve taking a leap into the unknown. It starts with a plan for turning small regular savings into something much more substantial over time.
With enough time and patience, I think it’s possible to build something that can generate £12,000 a year by investing as little as £100 a month. And the plan for doing this has three simple steps.
Step 1: find the monthly amount
It starts with £100 a month. It’s still possible to build a meaningful second income with less than that, but targeting £1,000 a month becomes much harder.
The average return from the FTSE 100 recently has been just over 8.5%. That rate eventually turns a monthly £100 investment into something that can return £12,000 a year.
It takes time – 30 years in fact – to reach the £1,000 monthly return. And there are no guarantees that stocks will return 8% a year going forward for that length of time.
Given this, one of the best things investors can do is start straight away. And another is to be as consistent as possible in investing that £100 every month.
There’s no denying that 360 months is a long time. But the way to think of it is like a marathon – and you can’t get to the 26th mile without first going through all the other 25.
That’s why the first step is to be consistent. The returns start off small, but it’s surprising how much they accelerate later on – for investors who can stay the course.
Step 2: target an 8.5% return
The next step is figuring out how to target an 8.5% annual return. History suggests that this is more than possible, but that’s no guarantee of future success.
Over the long term, the best way to aim for this kind of return is by focusing on quality companies. Even the best businesses will have ups and downs, but I expect them to outperform over time.
One example is Diageo (LSE:DGE). After falling 58% from its highs, the stock now comes with a 4.7% dividend yield, which gives investors a good start in aiming for 8.5%.
The rest of the return is going to have to come from growth. And the company has faced some challenges on this front in recent years, especially from the rise of anti-obesity medication that suppresses the desire for alcohol.
This is a risk, but there’s another shift that’s taking place at the same time. Within the alcohol industry, beer and wine are losing market share to spirits, where Diageo has a strong position.
My sense is that investors are focusing on one half of the equation much more than the other. And I think that’s created an opportunity that’s well worth considering at the moment.
Step 3: repeat
The third step is the easiest of them all: repeat the first two. Keep saving, keep looking for stocks to buy, and keep investing over the long term.
That doesn’t mean always buying the same stock (it’s better not to, in order to get to a diversified portfolio). But different opportunities make themselves available over time.
Earning a second income by investing in the stock market doesn’t have to be complicated. There’s always risk, but investors can give themselves the best chance with a simple plan.
