Turning $20,000 into an annual second income of $1,000 may sound fanciful. After all, real estate isn't exactly on the table with an amount of that size. And putting $20k into a savings account or even a term deposit won't get you anywhere near $1,000 in annual interest income with the latest interest rate cuts.
But it is possible using ASX shares.
Investing in the shares of an Australian company can be just as lucrative an investment as buying a house, perhaps even more so.
Just as real estate assets pay out rental income, many ASX shares pay their shareholders dividends for the privilege of owning them. These dividend payments usually arrive every six months on the ASX. Unlike rent, dividends can come with franking credits attached too, which makes them one of the most tax-effective passive investment options out there.
So, how does one get to enjoy a recurring annual income of $1,000 from a $20k investment?
Well, there are a few avenues to get there.
Image source: Getty Images
Buying high-yield ASX dividend shares
Firstly, you can buy an ASX dividend share (or exchange-traded fund (ETF)) with an upfront yield high enough to net you $1,000 right off the bat. Some quick maths will tell you that receiving a second income of $1,000 from a $20,000 investment requires an upfront yield of 5%.
There are a few prominent ASX shares that currently trade on dividend yields north of 5%. These include ANZ Group Holdings Ltd (ASX: ANZ) and Fortescue Ltd (ASX: FMG).
You will hit your $1,000 second income target by buying $20,000 worth of shares today, but (and this is a big but) only is these companies maintain or increase their dividend payments over the coming 12 months. This is never guaranteed on the ASX. So it's important to do your research and make an informed judgement whether these companies will be able to do so.
For example, commodity companies like Fortescue are notoriously cyclical, and typically raise and cut their dividends based on what he prices of the commodities they produce are doing.
Investing for a lucrative second income
Secondly, you can buy an ASX dividend share that might not offer a 5% yield upfront, but has such a robust history of regularly increasing its dividends that you will eventually hit, and exceed, 5%. A great example of this is Washington H. Soul Pattinson and Co Ltd (ASX: SOL).
Soul Patts has the distinction of being the only stock on the ASX that has increased its dividends every year since 2000. Since then, the company has averaged an annual dividend pay rise of 9.8% compounded.
Today, Soul Patts trades on a seemingly unimpressive dividend yield of 2.49% (at the time of writing). However, if the company keeps raising its dividend by 9.8% per annum (again, not guaranteed), it will take eight years before you will enjoy a yield on cost of 5% (5.25% to be specific). Another eight years at 9.8% will see the yield grow to a whopping 11.1%.
This approach might suit investors who have a longer time horizon and are willing to sacrifice a higher second income today to secure an even more lucrative income stream down the road.
