£20,000 in savings? Here’s how that can ultimately generate £672 for the second month
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Besides working extra hours, what are the possible ways to earn a second income?
Another is to invest some money in stocks that you hope will pay dividends. This can be very beneficial, especially for someone who has the patience to take a long-term approach to investing.
For example, if someone had a spare £20k available to invest in dividend stocks, here’s how they could target a second monthly income of £672.
Taking the long view
The key factor here is to allow dividends to fund additional share buybacks that will hopefully pay more dividends.
This is a simple but potentially very powerful financial step called compounding.
To illustrate how this works, imagine that £20k is compounded at an annual rate of 7.5% for 25 years. At the end of that period, without contributing new money, the portfolio should be worth around £122k thanks to compounding.
With a dividend yield of 7.5%, that should generate around £672 per month in the form of secondary income.
To cover costs
That compound annual growth rate can come from dividends, rising stock prices or both. But it’s important to remember that, since profits are never guaranteed, prices can go up and down.
Another factor that can eat into returns is the cost you pay to buy, sell or hold shares.
Therefore, it makes sense to shop around when it comes to choosing a trading account, Stocks & Shares ISA or trading app.
It aims for strong performance
Is a 7.5% compound annual growth rate achievable? After all, i FTSE 100 the yield is currently 2.9%.
By carefully choosing a diversified portfolio of stocks, I think it can be a realistic goal.
As an example, one stock that I think investors should consider is a paper producer Mondi (LSE:MNDI) with its 6.4% yield. Although Mondi is in the elite FTSE 100 index, it is a share that many small investors may not be familiar with. As an industrial supplier, it is not a consumer-facing brand.
However, Mondi is actually a large international company. Its footprint in many markets around the world gives it breadth and its range of packaging and paper products gives it depth.
Despite all that, however, the share price has more than halved over the past five years.
That was good because it increased the dividend yield. But it doesn’t seem like a crying deal for business. What’s going on?
Simply put, after high demand during the pandemic, the global mismatch between demand and supply has driven down packaging prices, hurting the industry’s profit margins.
That is a constant threat to Mondi. While during the half-year period, its cost of equity was comfortably covered by cash flow, other costs meant that the six-month period saw free cash flow overall. If that state of affairs continues, the shares may be terminated.
However, with a proven and large business, I am confident that Mondi can continue and hopefully benefit from the recovery in packaging prices at some point. That could increase the share price, and help support the dividend at its current or higher level.
