For many, £30k won’t go far funding a second income. However, lots of people have a similar sum saved. For example, various sources claim the average pension pot stands around £30,000 for those aged 35-44 in the UK.
That’s too little to fund a long, comfortable retirement. But mid-life is a great time to grab the savings and investment bull by the horns and work out a plan to improve the situation.
Taking control
Self-directed investing in stocks, shares and funds can be a good way to proceed. There are currently some decent tax advantages with Self-Invested Personal Pensions (SIPPs) and Stocks and Shares ISAs. So I’d use both as the main accounts for my investing activities.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
To begin with, it’s worth considering how much money it takes to fund a second income of £15k a year. There are two ways of looking at it.
We could use up all the money saved over a period of years. But a better way may be to deploy the capital built up to generate an income. For example, from interest or company dividends. But how much will the pot need to be worth?
One way of generating dividend income is by investing in a low-cost FTSE All-Share Index tracker fund. I like the idea because such funds are backed by many underlying businesses. So it’s unlikely they’ll all stop paying shareholder dividends at the same time in any crisis.
Right now (18 March), the median rolling dividend yield of the index is around 4%. That means I’d need £375k to fund a second income of £15k a year from FTSE All-Share dividends.
A lofty goal? Maybe. But alongside regular contributions from my income, I’d aim to invest well and take advantage of the process of compounding returns.
A robust dividend-payer
For example, several individual companies pay a higher dividend yield than the index. One is financial services provider Legal & General (LSE: LGEN).
With the share price in the ballpark of 244p, the forward-looking dividend yield is just above 9% for 2025.
That’s a chunky shareholder payment. I‘d gather the income in my share accounts and reinvest in dividend-paying companies. One option would be to buy even more L&G shares. In many cases, share account providers offer a low-cost service that reinvests dividends automatically.
One of the risks is L&G operates in a cyclical sector and that means its earnings and dividends may vary over time. It’s possible for both to move lower and the share price could fall too.
However, I’m encouraged by the firm’s robust multi-year dividend record. The compound annual growth rate of the dividend is running above 4%. L&G didn’t even cut its pay-out in the pandemic year, unlike many other companies.
Nevertheless, to spread the risks, I’d aim to diversify between several dividend-paying companies’ shares.
Compounding gains works best when carried out consistently and for a long time. So I’d start investing right away.
This post was originally published on Motley Fool
