£10k of savings? Here’s how I’d aim to turn that into a second income of £8,836 a year

£10k of savings? Here’s how I’d aim to turn that into a second income of £8,836 a year

I’m keen to build a substantial second income to top up my state pension when I retire, and I’m doing this by investing in FTSE 100 shares.

While UK blue-chips haven’t delivered much growth lately, they pay some the most generous passive income in the world. I’m building a portfolio of cheap, high-yielding stocks, and there are plenty to choose from right now.

Simply putting money in a Cash ISA or savings account isn’t enough, in my view. While it’s still possible to get 4% or 5%, this will almost certainly fall when the Bank of England starts cutting interest rates later this year.

I’m buying high-yield stocks

Through careful stock selection it is possible to get dividend yields of 5%, 6%, 7% or more. This is free of income tax for life inside a Stocks and Shares ISA, as is all capital growth.

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. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Unlike the interest in a cash account, dividends aren’t guaranteed. If a company cannot maintain its cash flows, they may be cut or scrapped altogether.

Higher yields can also be a sign of a struggling company. Yields are calculated by dividing a company’s dividend per share by its share price. So when the share price falls, the yield automatically rises.

Despite this, I think a number of FTSE 100 stocks offer high yields that may also prove sustainable. These include wealth manager M&G (8.95%), housebuilder Taylor Wimpey (6.40%), and Screwfix-owner Kingfisher (5.69%).

I hold the first two stocks, but I haven’t bought Kingfisher yet. It’s really cheap right now, trading at 7.33 times earnings. That follows a tough year, which has seen the share price crash 22.05%. That compares to a drop of 4.72% on the FTSE 100 over the same period, so it’s an underperformer.

That partly explains its high yield. Yet the dividend is nicely covered 2.4 times by earnings (a figure of two is usually more than sufficient). Analysts reckon Kingfisher will yield 5.67% in 2024 and 5.58% in 2025. The income stream looks steady, although it may not grow that much in the short term.

Dividends roll up over time

The £4bn group has been squeezed by the cost-of-living crisis, which has driven up input costs and hit demand from cash-strapped consumers. However, I think Kingfisher, which also owns B&Q and Castorama, should revive when interest rates start falling, the housing market picks up, and people have a bit more cash in their pockets.

I’m looking to build a balanced portfolio of around 12 stocks like these, so if one or two underperform, others will hopefully compensate.

Over the past 20 years, the FTSE 100 has delivered an average return of 6.9% a year, with all dividends reinvested. I hope to beat that by picking individual stocks.

Even if I don’t, if I invested a £10,000 lump sum at 30 and left it to grow until I turned 68, I’d have £126,227. If my portfolio yielded 7%, I’d get a second income of £8,836 a year. That’s not a bad return from an initial £10k.

Obviously, this assumes I start investing early and resist the temptation to raid my pot. I might get less than 6.9%, although I could make more.

FTSE 100 shares won’t make me rich overnight. Building a sizeable second income is the work of decades, but I’m hoping the rewards will make it worthwhile.

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Harvey Jones has positions in M&g Plc and Taylor Wimpey Plc. The Motley Fool UK has recommended M&g Plc. 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.