Generating a second income creates a range of choices in life, and starting to build it early is vital. The good news is that the ASX is home to many high-quality shares that pay generous dividends — a key part of this process.
How to build a second income with ASX shares
By making regular investments, reinvesting dividends, and maintaining a long-term perspective, you can embark on a journey towards financial freedom.
For example, if you were to invest $5,000 annually into high-quality ASX shares with strong business models and competitive advantages, you could grow your investment portfolio to $800,000 in three decades if you earned an average total return of just over 9% per annum.
This is lower than the actual market return over the last 30 years. So, while it is not guaranteed, it certainly is realistic.
The key to this wealth-building journey is the magic of compounding. As you consistently invest and reinvest your dividends, your investments begin to snowball. Over time, your initial contributions, returns, and reinvested dividends work together to grow your portfolio exponentially.
But eventually, there will come a time when you don't have to reinvest those dividends. Instead, you can use them as a second income.
Take the money and run
After patiently sticking with your investment plan and reaching your target portfolio value of $800,000, you can now start to focus on that second income.
By building a portfolio filled with ASX dividend shares offering yields of 5%, investors can turn this $800,000 into $40,000 of income each year.
The good news is that there are plenty of ASX shares offering yields of this size. This includes Aurizon Holdings Ltd (ASX: AZJ), BHP Group Ltd (ASX: BHP), Super Retail Group Ltd (ASX: SUL), and Westpac Banking Corp (ASX: WBC).
It is also worth noting that your $800,000 portfolio should continue to grow if history repeats itself and you generate a total return of 9%.
While you are taking out 5% of that return with your second income, there's still 4% left to grow your portfolio. This means that after just six years, your portfolio will have reached the $1 million mark. At which point, your second income will have grown to $50,000 if you are still earning a 5% dividend yield.
All in all, this demonstrates just how life-changing it can be to make long-term investments in ASX shares.