£20K of savings? Here’s how it could fuel a £633 monthly second income

The prospect of some extra money coming in is appealing – especially if it does not require extra work!  Not all second income streams require taking on another job.

Many people buy dividend shares, sit back and let income roll in in the form of dividends paid by the companies whose shares they own.

Here I explain how, if an investor put a spare £20,000 into such an approach today, they could target a £633 second income per month over the long term.

The same approach could also work with much less than £20k, but the income earned would be proportionately smaller.

Simple approach: successful companies distributing their profits

Dividends are basically one way for a company that generates excess cash to use some or all of it.

Not all companies make money and even when they do they may decide on other spending priorities. So, no dividend is ever guaranteed.

But this is not some sort of wild goose chase. Britain’s blue-chip companies collectively are big dividend payers. FTSE 100 companies alone pay out more than £1bn each week on average in dividends.

Even someone spending just a few pounds on a share is entitled to any dividend it earns, for as long as they hold it.

Getting started is simple

Such a second income strategy does not require stock market experience.

But, before investing a penny, it is important to get to grips with key concepts like how companies are valued, how they fund dividends, and how to reduce risk by techniques such as diversifying across multiple shares in different companies.

It is also necessary to have a way to invest – and costs can eat into the passive income streams.

So an investor ought to take time to compare different share-dealing accounts, trading apps, and Stocks and Shares ISAs to decide what seems best for their own needs.

Setting up the income streams

I said above such an approach could generate an average £633 each month in second income.

That involves a couple of assumptions. One is a compound annual growth rate of 7%, which is above the current FTSE 100 dividend yield but I think is achievable. A compound annual growth rate includes share price movements as well as any dividends.

I also assume the investor will reinvest dividends for the first 20 years, a simple but powerful wealth-building technique known as compounding.

Finding shares to buy

The market has lots of dividend shares from which to choose.

One I think an investor should consider is FTSE 100 financial services powerhouse Legal & General (LSE: LGEN).

It is a well-known and long-established business, something that helps attract and retain clients.

In recent years, it has focused its business on retirement-linked products. I see that as a smart move: there is never any shortage of retirees and the sums involved can be substantial, generating tidy commissions.

Over the past few years, Legal & General’s share price performance has not been especially noteworthy.

In part that reflects risks, such as economic uncertainty threatening to hurt investment returns and lead policyholders to withdraw funds.

But the big attraction I see here is the second income potential. The company has a dividend yield of 8.9%, so £100 invested today would hopefully earn £8.90 annually in dividends.