We’d all love a second income. And with interest rates pushing higher and UK stocks offering some enticing dividend yields, we’re presented with a host of opportunities to generate a second income — notably a passive one.
But when it comes to investing, we need money to generate money. So either we’ve got the cash, or we need time to create a bigger pot.
The ISA
The Stocks and Shares ISA is a tax-free vehicle for our investments. More than 3.5m of us have an ISA — it should be more — which can be used for capital growth or income generation. Every year I can put away as much asa £20,000 in the ISA wrapper.
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But today, I’m going to use £10,000 as my starting point. That’s half the allowance for a single year. This could represent a single cash injection or funds built up over a number of years.
So personally, I believe the highest sustainable yield currently available is around 8%. That involves investing in companies like Phoenix Group and Barratt Developments.
But if I only had £10,000, investing in companies averaging an 8% yield would only give me £800. That’s fine, but it’s not going to impact my life hugely.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Building a bigger pot
In order to achieve £8,000 in dividends a year, I need to turn my £10,000 into £100,000. So how do I do this?
Well, it’s going to take time. Unfortunately, that’s normally the way with investing. Some investors can be attracted to the potential of growth stocks, but it’s worth remembering that many companies never deliver the promised growth — in fact, many fail entirely.
For my sins, I used to trade Novavax shares. Back then, the biotech firm was trading between $130-$300. Today, it’s worth just $8. I didn’t lose money, but many people did. This is just one of the companies that enticed novice investors as the price soared.
Instead, I’m using a compound returns strategy to try to turn £10,000 into £100,000. This is the process of reinvesting my dividends year after year.
Essentially, people who already have money find it easier to get more money just by leaving their investments to grow. It’s very much like a rolling snowball effect. The longer I leave it, the larger the pot becomes.
So if I invested in stocks with 8% yields, and reinvested over 29 years, I’d potentially have £100,000.
But if I wanted to get there quicker, I could make regular contributions. If I contributed an additional £200 a month and increased my contributions by 5% a year, it would only take me 13 years to reach £100,000. In fact, after 30 years I’d have over £600,000. But of course, I might not manage those percentages and could even lose money.
Patience
Assuming it works, this investment strategy takes time and patience, as well as frequent contributions. But it’s one that can be hugely rewarding over time. With £100,000, I could draw down £8,000 a year, or, if I don’t need it, continue to reinvest.
