$20,000 in savings? Here's how you can use that to target an $8,000 yearly second income

Having $20,000 saved is more powerful than most people realise. Not because $20,000 can produce an income today, but because it can become the foundation of a portfolio that eventually pays you thousands of dollars a year without lifting a finger.

If your goal is to build a second income of around $8,000 annually, let's see how you could get there with the help of the share market.

Focus on compounding

If you were to receive a 5% dividend yield from a $20,000 ASX share portfolio, you would be pulling in $1,000 a year in income.

While this is certainly very welcome, it is well short of our target.

So, we first need to think about compounding before we start to focus on a second income.

Compounding is what happens when you earn returns on your returns. It is like a snowball rolling down a hill. At the beginning, it feels slow. You put in money, you reinvest dividends, and your portfolio barely seems to move. But with time, the snowball grows, and the larger it becomes, the faster it accelerates.

For example, if you were starting with $20,000 and were able to grow it at 10% per annum, which is largely in line with historical returns, your portfolio would grow to roughly $52,000 in 10 years, $84,000 in 15 years, $135,000 in 20 years, and $160,000 in 22 years. That's even without adding anything more along the way.

Add a regular contribution, even something modest like $250 or $500 a month, and the numbers rise far more quickly.

In fact, by adding $500 a month to your portfolio, it would grow to $160,000 after just over 10 years.

At that point, you now have enough to start pulling in meaningful second income from your portfolio.

Second income

With a $160,000 ASX share portfolio, you would need to average a 5% dividend yield to generate an $8,000 second income.

Thankfully, the Australian share market is one of the most generous markets in the world. So, building a portfolio that averages a 5% dividend yield is much easier than you think.

Examples include APA Group (ASX: APA), GQG Partners Inc (ASX: GQG), and Rural Funds Group (ASX: RFF), along with the Vanguard Australian Shares High Yield ETF (ASX: VHY). The latter includes a range of high yield ASX shares from different sectors.

Foolish takeaway

With a combination of compounding and additional capital, it is easier than you think to generate a second income from the share market.

You just need to be patient and consistent, and compounding will do the rest.

The post $20,000 in savings? Here's how you can use that to target an $8,000 yearly second income appeared first on The Motley Fool Australia.

Motley Fool contributor James Mickleboro has positions in Gqg Partners. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has positions in and has recommended Apa Group and Rural Funds Group. The Motley Fool Australia has recommended Gqg Partners and Vanguard Australian Shares High Yield ETF. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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