How I’d invest £300 a month in UK shares to target a £30,855 annual second income

Investing regularly in UK shares could provide ample additional income and even help me build a sizeable retirement nest egg.

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The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

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Owning UK shares can build substantial wealth for patient investors. Given sufficient time, high-quality mid-cap and even small-cap stocks can deliver big returns that can unlock an impressive income stream. Even for an investor that can only spare £300 a month, that’s enough to potentially establish a second annual income of £30,855.

Investing for long-term growth

The most popular stock market index in the United Kingdom is the FTSE 100. However, the FTSE 250 may be more suitable for growth-seeking investors. Why? Because the index contains almost exclusively medium- and small-sized enterprises with significantly greater growth potential than the stalwarts inside the UK’s flagship index.

In fact, since its inception in 1992, the UK shares inside the FTSE 250 have delivered an average annualised total return of 10.6%. And that’s even after dropping by nearly 20% in 2022. By comparison, the total annual returns of the FTSE 100 over the same period are closer to 7.1%.

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Let’s assume these indices continue to deliver these average returns for the next 30 years. What would a £300 monthly investment transform into?

FTSE 100FTSE 250
5 Years£21,533.55£23,603.20
10 Years£52,212.18£63,610.24
20 Years£158,189.35£246,360.45
30 Years£373,295.47£771,395.97

Needless to say, the 3.5% difference in returns, compounded over three decades, has an enormous impact. And by following the 4% withdrawal rule, a portfolio worth £771,396 would provide an annual income of £30,885.84.

UK shares can be volatile

As exciting as the prospect of earning £31k for doing nothing is, there are some risk factors to take into consideration. The higher returns of the FTSE 250 aren’t without their risks. As I said previously, the index can be volatile.

With economic instability rising courtesy of expanding inflation, many UK shares were pummelled into the ground last year. And the majority were mid- and small-cap stocks. Why? Because these smaller companies typically have fewer resources at hand to weather bad operating environments. On the other hand, large-cap stocks can leverage their size to withstand such storms and are usually more resilient.

Nothing paints this picture more clearly than comparing the performance of the FTSE 250 versus the FTSE 100 in 2022. The former lost nearly a quarter of its value, while the latter actually ended the year up.

Stock market downturns are infrequent. But they can significantly derail the wealth-building process. As such, the average returns over the next 30 years may be lower than what has historically been achieved. In other words, investors may have to wait longer to achieve desired income milestones.

The bottom line

Buying UK shares is far from a risk-free endeavour. But, as demonstrated, it can unlock substantial wealth and accelerate the journey towards financial independence. That, in my opinion, makes these risks worth taking.

Passive income stocks: our picks

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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.

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