£10k in savings? Here’s how I’d aim to turn it into a second income of £500 a month

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If we had £10,000 in our pockets, it would be seriously tempting to buy something nice rather than think about investing it, right? Well, I’d say a second income later in life could do a lot more good than a one-off splurge today.

But £10,000 isn’t enough to retire on, and it’s not going to earn £500 a month, is it? That’s £6,000 a year, or an annual return of 60%.

Even billionaire investor Warren Buffett couldn’t do that over the long term. Since he took over at investing firm Berkshire Hathaway in 1965, he’s averaged annual returns of 20%.

That’s great stuff. But we could build to a steady monthly £500 with more modest returns.

Generating income

We need something that pays regular income and lets us plough it back into more of the same. Then a thing called compounding can do its work.

Albert Einstein is said to have called it “the eighth wonder of the world”. I’m not sure if he really did, but the effect of it can seem like magic.

What kind of investment could do what we want? For me, it has to be shares in UK companies that pay dividends.

Today, there are more than 4,000 Stocks and Shares ISA millionaires in the UK. I don’t know of a single Cash ISA millionaire.

Strategy part 1

So my £10,000 would go into a selection of FTSE 100 dividend stocks. Not necessarily with the biggest dividends, but ones with a track record of earning the cash to cover them.

I’m thinking of companies like Aviva, with a forecast 7.8%, or NatWest Group, on 6.8%.

The secret to making the most of compound returns is to start early and invest for as long as possible. So though my £10,000 might not make much profit in the early days, it could build up nicely over the years.

Strategy part 2

But there’s one extra secret, which isn’t actually all that secret. Keep adding to our investments — regularly every month, if we have a windfall, whenever we can.

So I’d start with my £10,000 pot and then add regular cash to it. How much I end up with will depend on what returns I get. And over the past 20 years, we’ve seen an average FTSE 100 return of 6.9% a year.

The result?

If I manage that, buy my shares in a Stocks and Shares ISA, and I can add £100 to my pot every month, how much might I build up?

Well, I work out that it could get me to a pot of about £88,400 in 20 years. I’d then need to take about 5.7% from that annually to get my £500 second income each month.

Now a lot of things can change, and I might not do as well as that. But I do think that if I stick with the FTSE 100’s best dividend stocks, and trust my money to them, I should boost my chances.

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Alan Oscroft has positions in Aviva Plc. The Motley Fool UK has no position in any of the shares mentioned. 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.

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