With the interest rate increases over the past year, many are more focused on the return being earned on cash savings. I still think the major banks are offering pretty poor savings rates, making it hard to generate a meaningful second income from the money. However, if I flip to making use of the stock market, it can be a different story.
Pros and cons
Comparing a savings account yield to the dividend yield from a stock isn’t a perfect match. To begin with, earning passive income from my cash in the bank doesn’t carry with it any risk of losing my initial amount of investment.
This can’t be said of the stock market. When I buy a stock that pays a dividend, I’m open to the fluctuations in the share price. So even if the dividend yield is 5%, if after a year the share price has fallen by 5%, my overall return for that period would be 0%.
Yet the share price has the potential to rally. This would provide me with an added gain that cash in the bank could never do.
Comparing the yields
Another factor to consider is the type of yields available. It’s highly unlikely that I could find a savings account paying exactly the 5.25% base interest rate. Yet with a stock, there’s no cap on how high the yield could be.
Of course, if I see a dividend yield above 10%, I’m a bit cautious about how sustainable this could be. Yet there are plenty of firms with a track record of paying dividends that carry a yield in the 5-10% bucket.
Putting the £10k to work
After deciding that I prefer using my savings in the stock market, I want to make best use of my money without taking on excessive risk.
From my calculations, I’d look to buy 10 stocks that yield 6-8%. This would provide me with an average yield of 7%. This would include the likes of Bakkavor Group, the Supermarket Income REIT and Land Securities Group.
I’d choose this range of companies so that my income potential is diversified. The last thing I want to happen is to put £10k in one stock that stops paying a dividend next year.
In theory, I should get paid £700 after the first year. I’m going to reinvest this back in the market to build up my portfolio.
Without adding in another penny of my own money, after 15 years, the pot should have grown to a level to pay out £2k in year 16.
Some might say this is too long to wait. In that case, I could look to invest an extra £100 a month beyond my initial £10k lump sum. By doing this, I could reach my goal in just under eight years.
The post £10k in savings? I’d aim to turn it into a £2k annual second income appeared first on The Motley Fool UK.
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Jon Smith has no position in any of the shares mentioned. The Motley Fool UK has recommended Land Securities Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
