ASX shares can be a great tool to use to unlock a second income of $1,000 per month. I wouldn't be concerned even if I had no savings because of the potential of compounding.
Bank savings accounts are finally offering a decent interest rate. Having money parked in a high-interest savings account can earn a decent rate. But, I think there's less compounding potential than ASX shares – businesses can grow their profit while paying a (growing) dividend. Investors can decide to spend those dividends and still get growing passive income or decide to re-invest the dividends for even stronger wealth-building.
The first step, and perhaps the hardest, is to save money to invest. That requires spending less than you earn, one way or another.
I'd try to save at least $750 a month by making some changes with my spending choices, though each household's finances are different – some people may be able to save $500 per month while others may be able to invest $2,000 per month or even more.
When we've got some cash, we need to decide where to invest it. Receiving $1,000 per month is equivalent to $12,000 per year. Getting that much of a second income could require a portfolio worth $300,000 (at a 4% dividend yield or 4% withdrawal rate).
Where to invest it?
There are three different ways that I'd consider investing my savings to build my portfolio.
I'll just mention that all of the financial numbers mentioned below are just for demonstration and generally don't account for tax, as I'd need a crystal ball to know what future returns are going to be and what's the best option for each individual circumstance.
Index-based ETFs
Index-based exchange-traded funds (ETFs) are funds that allow people to invest in a portfolio of businesses. They're usually low-cost, offer good diversification and track the returns of the share market.
An example is the Vanguard MSCI Index International Shares ETF (ASX: VGS) is an ETF that invests in the global share market, owns more than 1,400 businesses and has produced average returns per year of more than 10% over the long-term, though past performance is not a guarantee of future performance.
I would keep investing $750 per month in this ETF and re-invest the distributions until I'd reached a minimum of $300,000. If the VGS ETF returned an average of 10% per annum, then this would take 15 years.
To unlock a second income, I'd then sell 4% of the ETF's value each year to get $12,000 per annum out of the portfolio.
ASX growth shares
Another option could be to choose ASX growth shares that may be able to grow in scale significantly and create wealth. If an investor chooses right, they may be able to grow their wealth the most with this path, but it can also come with more risk.
It's very hard to say what the future returns of each individual growth share are going to be.
I believe there are some growing businesses that could pay much larger dividends in the future, funded by the growing profit. Those ASX growth shares could pay the required dividends for a second income in 10 or 15 years. I'd look at names like Lovisa Holdings Ltd (ASX: LOV), Johns Lyng Group Ltd (ASX: JLG), Healthia Ltd (ASX: HLA) and Bailador Technology Investments Ltd (ASX: BTI).
Some ASX growth shares don't pay dividends but are very promising to me, such as Xero Limited (ASX: XRO), Temple & Webster Group Ltd (ASX: TPW) and Volpara Health Technologies Ltd (ASX: VHT). They may pay dividends in the distant future, but buying these sorts of names could require selling 4% of the $300,000 portfolio value to unlock $12,000 of a second income.
I would also consider investing in a growth-focused ETF like the Vaneck Morningstar Wide Moat ETF (ASX: MOAT) if I were thinking with a growth mindset and then sell 4% of the value each year.
ASX dividend shares
A final option to consider could be to choose ASX dividend shares that could deliver solid capital growth and are already paying a good dividend yield.
If these ASX dividend shares keep growing their profit and dividend, we could just live off the dividends and not need to think about selling any of the portfolio. Plus, there would probably be some helpful franking credits coming from these names to boost the yield.
Three of my favourite ideas for an ASX dividend share portfolio that could also deliver growth would be Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Brickworks Limited (ASX: BKW) and Wesfarmers Ltd (ASX: WES). I'd also consider names like Premier Investments Limited (ASX: PMV) and Sonic Healthcare Limited (ASX: SHL).
Foolish takeaway
I think each of the avenues I've talked about can help unlock a second income. The ETF route (including the MOAT ETF) would probably be the simplest path, as I wouldn't need to worry about which ASX shares to own.
However, the ASX dividend shares route is the one I'm pursuing with my real portfolio because I like the cash flow and franking credits that are created by that route.
For my own portfolio, I like the long-term record that Soul Pattinson and Brickworks have already demonstrated for dividends and wealth creation, and I think that can continue.
