Here's how I'd target a $2,000 second income by investing $35 a week

This would be my strategy to make investment income.

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The Australian stock market has the potential to generate a second income of $2,000, $10,000 or even more. I believe it's possible to unlock that investment cash flow by saving a small amount each week.

ASX dividend shares have the capability to provide a good dividend yield, growing dividends and capital growth.

Businesses don't need to have a dividend payout ratio of 100%, paying out all of their profit, to deliver a good dividend yield. Franking credits can be a big boost to the after-tax dividend yield from Australian companies because of their refundable nature.

If I were trying to deliver a second income of $2,000 by saving $35 a week, I'd pursue one of two strategies.

High-yield ASX dividend shares

Choosing stocks with a large dividend yield can mean investors don't need to grow their investment balance as high.

For example, if someone had a portfolio with a 2% dividend yield, they'd need a portfolio worth $100,000 to generate $2,000 of annual dividend income. However, if that portfolio had a 6% dividend yield, an investor would only need a portfolio worth $33,333 to generate $2,000 of dividend income.

Using the Moneysmart calculator, if I saved/invested $35 per week and that portfolio made returns of 10% per annum, it would take 11 years to reach a balance of $33,727, assuming all the dividends are re-invested. Meanwhile, it would take 20 years to reach a portfolio value of over $100,000.

For a portfolio of high-yield ASX dividend shares, I'd want to own businesses with good longer-term earnings drivers that operate in appealing industries. A high yield alone is not enough to make a good investment.

Examples of high-yield stocks I've written about recently include Metcash Ltd (ASX: MTS), GQG Partners Inc (ASX: GQG), Rural Funds Group (ASX: RFF), Medibank Private Ltd (ASX: MPL), Bailador Technology Investments Ltd (ASX: BTI) and Charter Hall Long WALE REIT (ASX: CLW).

However, these stocks usually have a lower earnings growth rate, partly because they are not re-investing as much profit as they could.

Dividend growth stocks

Another way to invest for a second income is to choose growing businesses that tend to increase their payouts for investors. Owning those ASX shares means our dividend income is increasing organically, hopefully at a pleasing rate.

These growing stocks typically start with a lower dividend yield because the market is taking into account the potential earnings growth in the coming years. Over time, those stocks can keep hiking the dividend, leading to a stronger yield on cost.

I look to buy these types of businesses for my dividend portfolio because earnings growth can promote share price growth. The market usually values a business based on its profit.  

In terms of specific examples, I've invested in Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Brickworks Limited (ASX: BKW), Collins Foods Ltd (ASX: CKF) and Johns Lyng Group Ltd (ASX: JLG).

As I mentioned, the dividend yield is usually lower with these stocks. If we assume a grossed-up dividend yield of 3.5%, we would need a portfolio of $57,000.

Ultimately, I think the dividend growth stock method is a better choice for a second income because of the compounding effects of earnings growth and capital growth. The amount of dividends is important, but capital growth dollars are rewarding too, particularly if/when you sell shares.

Motley Fool contributor Tristan Harrison has positions in Bailador Technology Investments, Brickworks, Collins Foods, Johns Lyng Group, Metcash, Rural Funds Group, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Bailador Technology Investments, Brickworks, Johns Lyng Group, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia has positions in and has recommended Brickworks, Rural Funds Group, and Washington H. Soul Pattinson and Company Limited. The Motley Fool Australia has recommended Bailador Technology Investments, Collins Foods, Johns Lyng Group, and Metcash. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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