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How much is 20,000 pounds worth? It may seem like a silly question. They are worth 20,000 pounds, nowBut what if it could be worth more than £40,000? in the futureNot as a sum of money, either, but as a annual Second income?
I think it's possible, but turning a lump sum of £20,000 into an annual income stream of more than double that (plus a significant capital gain) is a serious project – it takes time and the right strategy. Here's how I would do it, in three steps.
Step One: Move the money to the right place
My plan is to generate income in the form of stock dividends, so I need to be able to use them to buy stocks.
To do this, my first step would be to open a stocks and Values ISA and deposit money into it.
Step Two: Distribute it across five to ten top-line stocks
I would then invest the money evenly across five to ten blue-chip stocks.
Why not just one? The unexpected can happen, so I need to spread the risk.
I would look for large companies with attractive valuations, which I believe could generate excess cash and pay substantial dividends regularly for decades to come. Yes, decadesnot years.
Step Three: Capitalize Dividends
I would reinvest the dividends by buying more shares.
This is like a turbocharger for my (hopefully good) investment choices. Let's say I can compound my £20,000 a year at a rate of 8%, after 42 years my portfolio should be worth more than half a million poundsIf I can invest that money to earn an 8% return, I would have a second income of £40,543 a year.
I know, 42 years is a long time (or at least it seems that way at first). As I said before, this is a serious plan and it takes time. (I could always start collecting my income earlier, in fact at any time, but I would have to settle for less.)
So what kind of stocks should you buy?
The theory sounds very good.
However, over the long term, an 8% compound annual growth rate is actually harder to achieve than it seems. After all, we have to take into account the bad or stagnant years as well as the good and bright ones.
I think it is possible, if one selects the right stocks.
Let me illustrate my approach by referring to the type of front-line action I have in mind: Legal and general (LSE: LGEN).
Looking at my list of blue chip investments: is it in an industry where I expect to see strong customer demand over the long term? Yes. Does it have a competitive advantage? Yes, thanks to an iconic brand and an existing customer base. Is the valuation attractive in my view? Yes – the £13.4bn market cap sounds good to me.
And what are the risks?
What I see is a financial crisis that severely damages demand just as asset valuations are collapsing. That could lead to dividend cuts, as happened in the last financial crisis.
The dividend yield is 9.1% and the share price has dropped by 2% in five years. I am optimistic about its future.