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Investors looking to earn a second income through the stock market don’t strictly need to have a lot of cash available at the outset. But it can be a big help.
Investing is a long-term activity, but the most important years are the early ones. It can feel like not a lot is happening, but they’re the years that make the most difference.
Compounding returns
A £20,000 investment that yields 6.5% annually returns £1,300 in the first year, which might not sound like much. But reinvesting over time can boost that number substantially.
After 10 years or reinvesting, the annual return reaches £2,291 and this increases to £4,301 in year 20 and £8,073 after year 30. In terms of a second income, that’s much more like it.
The thing is, though, there are no shortcuts. There’s no way to get to year 30 – and access the 30-year return – without first going through all of the returns for the previous years.
That’s why, as I said, the first few years are the most important. Getting them out of the way puts investors closer to unlocking bigger returns and brings them closer to the big pay-off.
Cash is king?
Starting sooner is a big advantage in terms of accessing higher returns in future years. And that means it’s also helpful to be able to invest as much money as possible early on.
After 30 years, the difference in annual income between investing with £20,000 at 6.5% at the outset, and £55 a month at that rate is £4,490. In other words, more up front means more later.
The reason for that is straightforward. A bigger initial investment means more of the overall outlay benefits from a longer time period, which is what generates the big returns.
Investing more gradually over time can help moderate the risk of a stock market crash. But if the general direction of stocks over time is up, it’s better to be invested as early as possible.
What to buy?
The obvious question is what to buy to target a 6.5% return. And I think FTSE 250 real estate investment trust (REIT) Primary Health Properties (LSE:PHP) is well worth a look.
A 7.5% dividend yield is often a sign investors are worried about something. But in this case, the firm has a portfolio that’s largely occupied by a very reliable tenant – the NHS.
The firm has also recently merged with Assura, which used to be its main rival. Aside from any efficiency savings, this should have the effect of strengthening its negotiating position.
The requirement to distribute their income as dividends means growth is often a challenge for REITs. But with a 7.5% starting yield, investors might question how much they really need.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice.
Risks and rewards
Stocks always come with risk. And one thing to note with Primary Health Properties is the mismatch between its five-year average debt maturity and its nine-year average lease expiry.
That means the firm can’t easily increase rents to offset higher costs when the time comes to refinance. But I think this is something to be managed, rather than avoided.
Investors might therefore consider owning the stock as part of a diversified portfolio, rather than a standalone pick (and of course, diversification is important whatever the stocks held). Fortunately, I think there are enough other opportunities to make an £8k (eventual) income achievable.
