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Here’s how I’d aim to build a powerful second income portfolio with just £20,000

Black father and two young daughters dancing at home

The annual contribution allowance for a Stocks and Shares ISA currently stands at £20,000. If I had that much to invest today, I’d open an ISA and attempt to turn it into a portfolio capable of generating a significant second income. Here’s how.

Let there be growth

Firstly, my £20,000 is going to need to grow. So I’d start with growth shares listed on the London Stock Exchange. And I’d diversify my portfolio to reduce the risk of any single stock plunging and severely damaging my returns.

As an example, I could invest in Games Workshop, Ashtead, and Creo Medical. These are some of my favourite UK growth shares today.

They all have promising long-term growth prospects, but are in three different industries — consumer discretionary, industrials, and healthcare. And they’re different sizes too.

Market cap Size group Index
Ashtead £23.5bn Large-cap FTSE 100
Games Workshop £3.5bn Mid-cap FTSE 250
Creo Medical £122m Small-cap AIM

Additionally, I’d give my portfolio a bit of international balance by also adding growth stocks listed in the US. Some of my best long-term ideas include Intuitive Surgical, Airbnb, and MercadoLibre.

However, I’d be careful investing today, as some valuations in the tech sector across the pond are a bit stretched right now.

Therefore, it may be better to drip-feed my money in over a few months. This is called pound cost averaging, and can provide some protection against the possibility of a sudden market drop after I first invest.

Finally, I’d round off my portfolio with a smattering of investment trusts. These would provide further diversification because each one tends to hold between 30 and 100 individual stocks.

That’s a nice mix, I feel.

Time is an investor’s best friend

Except for Creo Medical and Airbnb, the stocks above have all delivered terrific long-term returns. But there’s no guarantee that run will continue, as past performance is no reliable indicator of future returns.

Having said that, I do think it’s entirely realistic for such a growth portfolio to produce a compound annual growth rate (CAGR) of 10%. But this would be over a 25 year-period, which is long enough to smooth out the inevitable ups and downs of the stock market.

With this rate of return, my initial £20,000 would turn into £216,695 after 25 years.

This portfolio would be large enough to start throwing off impressive sums of cash.

Now let there be passive income

At this point, I could sell those growth stocks and buy a bunch of FTSE 100 dividend shares with high and reliable yields.

Again, I’d want to diversify to reduce the impact of any specific income stocks not paying out, which is always possible.

However, there’s no point me naming a bunch of dividend stocks because I don’t know which companies will still be around in 15 years time. And therefore I have no idea what sort of yield I could hope to find.

That said, many UK stocks do regularly yield between 8% and 10%. So, taking the median of that range (9%), my portfolio would be producing annual passive income of £19,500.

But what if I’d also chipped in £100 a week along the way?

Well, in that scenario, I’d end up with £750,000 generating an annual income of £67,500!

The post Here’s how I’d aim to build a powerful second income portfolio with just £20,000 appeared first on The Motley Fool UK.

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Ben McPoland has positions in Airbnb, Ashtead Group Plc, Creo Medical, Games Workshop Group Plc, Intuitive Surgical, and MercadoLibre. The Motley Fool UK has recommended Airbnb, Games Workshop Group Plc, Intuitive Surgical, and MercadoLibre. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.