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Earning a second income by investing in blue-chip stocks is a proven model that many people are already using to increase their earnings.
It's not foolproof. Dividends are never guaranteed, even for companies that have paid them consistently in the past. But by carefully selecting a diversified range of stocks, I believe it is possible to build up significant passive income streams.
If that was my goal and I had £20,000 in a stocks and shares ISA to try and make it happen, here are three steps I would take.
1. Build a high-quality stock portfolio
Some stocks offer sky-high dividends, but they may not last. Rather than putting all my second-income eggs in one basket, I would spread the £20,000 across five to ten different stocks.
In this plan, dividends will be my source of income, so yield is important: the higher the yield, the more I should earn relative to what I invest. But simply chasing yield can be a futile task.
My starting point would be to identify excellent companies that I believe are trading at an attractive share price. Only then would I analyse performance.
2. Reinvest dividends along the way
Once I've purchased those shares, I would reinvest the dividends. That simple action would allow me to buy more shares, which would increase my portfolio and hopefully the income it would generate.
This is known as compound interest and can be a very powerful tool for long-term investors, as it increases the amount of income earned without the need to invest more money into the ISA.
For example, if I invest my £20,000 ISA and grow it at 7% per year, I should generate a second income of £5,418 each year in the future.
In today's market, I think an average yield of 7% is viable even if we limit ourselves to blue-chip companies. As an example, let's consider a stock I own that actually has a higher yield right now, at 9.5%: M&G (LSE: MNG).
The asset management market is huge and I expect it to remain that way over time. M&G has a well-known brand and has spent decades building a client base that spans over two dozen markets and numbers in the millions. It has proven that it can generate substantial surplus cash from its operations, which supports a substantial dividend. Indeed, it aims to maintain or increase its dividend annually and has done so for the past few years.
Whether this continues or not will depend on how the business fares. One risk I see is that the next market crash will spook investors, leading them to pull funds out of M&G and hurt its profits.
3. Take a long-term approach
However, as a long-term investor, I still think the outlook for M&G is good.
The long-term approach is central to my plan. I said earlier that if I add £20,000 at 7% I expect to have a second income of £5,418 in the future.
How long until that happens? 20 years. It may seem like a long time, but I think patience will pay off.
