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How I would like to build an amazing second income of £46,387 a year starting from £2.50 a day
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How I would like to build an amazing second income of £46,387 a year starting from £2.50 a day

How I would like to build an amazing second income of £46,387 a year starting from £2.50 a day

Image source: Getty Images

I am making a second income from the UK shares with dividends to top up my state pension in retirement and I’m aiming high.

I believe it is possible to build a high and growing passive income by investing the equivalent of a small amount every day. Say £2.50, less than the price of a coffee. The key is to sustain it for the long term.

I am building a mostly balanced portfolio FTSE 100 top stocks that give me a combination of dividend income and share price growth, plus some smaller growth stocks from FTSE All-Share.

As I work, I will reinvest every dividend I receive, which will buy me more shares. With luck, they’ll pay me more dividends in the future, which will buy more shares, which will pay more dividends…in a never-ending virtuous cycle.

I’m building my retirement on FTSE 100 shares

I invest monthly by direct debit so I don’t think about the process. When I have money to spare, I invest more.

I target stocks that I can buy and hold for the long term to allow dividend income and share price appreciation to compound.

A FTSE 100 dividend growth stock I would have liked to own, but unfortunately it’s not a distribution group Diploma (LSE: DPLM).

It’s not a household name, which is perhaps not surprising, since it makes unglamorous industrial products such as seals, gaskets, filters, wiring harnesses and connectors for businesses in North America and Europe. It’s easy to overlook its dividend potential given its modest 1.3% yield.

However, this is largely due to the amazing increase in the share price. Shares are up 52.95% in 12 months. It has grown 170% in five years.

Yields are calculated by dividing the dividend per share by the share price. So if the price goes up, the yield goes down.

The staggering share price growth belies Diploma’s dividend track record. Over the past decade, the board’s dividend payments have grown at an average rate of 13.7% per year, according to AJ Bell. The total return during that period is 620.2%.

Dividends are not guaranteed and AJ Bell expects to grow at a slower pace going forward, rising 5.2% in 2024 and 5.4% in 2025. Diploma plans to grow through acquisitions, but this always involves a element of risk, because catching a new business takes time and does not always generate the anticipated rewards.

Watch the dividends grow

The long-term average total return of the FTSE 100 is closer to 8% per annum. Let’s say I invested £2.50 a day for 30 years in a portfolio of 15-20 stocks and matched the 8% return.

Let’s also assume that I increase my contribution by 10% each year. After 30 years, I would have an impressive £363,982.

If I took just 4% of that every year – known as the safe withdrawal rate – I’d get a second income of £14,559 a year.

The more I invest, the better. If I could continue this for 40 years, I’d end up with £1,159,674, more than three times as much. Taking 4% each year would give me a fabulous second income of £46,387 a year.

Of course, dividends and stock price growth are never guaranteed. Stock markets can be volatile. My portfolio could follow the FTSE 100 or beat it. Either way, I would expect £2.50 a day to turn into something substantial with minimal effort and sacrifice on my part.