Building a £100,000 second income is no easy feat. At least, not for those who don’t already have a seven-figure net worth. But by leveraging the power of compounding returns in the stock market, building a passive income of this size in the long run is more achievable than most would think, even when starting with just £1,000.
Crunching the numbers
Let’s start by figuring out exactly how much a portfolio would need to grow to generate a six-figure income. On average, British dividend stocks offer a yield of 4%. But by being a bit more selective, it’s possible to push this to 5% without taking on too much extra risk. Yet, even with this slight boost, an investor would still need a £2m portfolio to hit the £100,000 income target.
So how can investors turn £1,000 into £2m? One method is to dive into the realm of penny stocks. These are tiny companies. However, given enough time, they could develop into future industry leaders. After all, that’s precisely what’s happened with some of the largest companies in the world today. Fun fact: a £1,000 investment in Apple (NASDAQ:AAPL) when it was a penny stock in 1986 is now worth over £3.1m.
So all investors have to do is find the next Apple. Sadly, the vast majority of penny stocks fail to deliver, and investors are often left with nothing. In other words, this is an exceptionally high-risk strategy.
Can we reach £2m without sky-high risk?
No investment in the stock market is risk-free. However, there are significantly safer ways to invest than penny stocks. And in many cases, these can still be highly lucrative if investors are willing to drip feed more money over time.
For example, the FTSE 100’s generated a long-term average return of around 8%. However, by selecting individual high-quality stocks, it’s possible to boost this return. Even a 2% boost can make an enormous difference in the long run. And investing £500 a month on top of the £1,000 starting capital at 10% can build a £2m portfolio in about 35 years. Then it’s just a matter of switching strategies around from growth to dividends to start earning a £100,000 second income.
Of course, this introduces a new challenge. What makes a stock high quality? Let’s zoom in again on Apple. What made it so successful?
The firm’s cultivated enormous pricing power driven by a cult-like following from its customers. After all, it’s not uncommon to see massive queues lining up outside its stores whenever a new iPhone’s released. Such behaviour also signals a reputation for quality to non-Apple customers. And that might just be the convincing factor to convert a new iPhone user.
This is just one of many competitive advantages Apple has leveraged over the years. Obviously, there are other factors to consider. Even Apple’s exposed to risks today, such as the brewing trade war between the US and China, where the firm manufactures most of its products. Nevertheless, filtering out companies that don’t have a discernible advantage over their rivals can quickly eliminate a lot of losing investments from consideration.
This post was originally published on Motley Fool
