When you think about a second income, what comes to mind? For many, it will be an extra job, maybe weekends or evenings. Or renting out a room, perhaps.
But my favourite way needs very little effort. I’m talking about a Stocks and Shares ISA. I have to do a bit of work to decide what to to buy, and for me it’s FTSE 100 companies paying good dividends.
But then all I need to do is sit back and watch the cash roll in. Well, that’s the plan.
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But sometimes a dividend can be cut or even suspended. That happened to bank dividends when the pandemic hit. But it was only a short-term thing, and they’ve already bounced back.
Tax-free income
Right now, Lloyds Banking Group is on a forecast dividend yield of 5.7%, which looks good to me.
But how can that help me towards a tax-free second income of £750 per month? That’s £9,000 per year. And even if I could invest my full £20,000 ISA allowance, I’m not likely to earn that much right away. But I could still get there, given time.
In the UK, there are now about 2,000 ISA millionaires. And none has been able to invest more than £20,000 in any one year. And the further back we go, the less they could stash away.
Even if my goal is less lofty than a million, the same bit of magic could still build my investment cash into the kind of sum I’d need.
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.
Compound returns
That magic is called compounding. And all I have to do is buy more shares with my dividend returns each year.
Over the past 10 years, Stocks and Shares ISAs have returned an annual average of 9.6%. It varied a lot mind, and 2019-20 saw a 13% loss.
I doubt we’ll see 9.6% sustained in the long term. But might 8% be reasonable? Right now, I count nine FTSE 100 stocks with dividend yields of 8%, or higher.
If I could invest a single ISA allowance of £20k, and I earned 8% a year, what might I expect? Well, at that rate, it should take about 23 years to grow to the amount I’d need.
Assuming I could still rake in my 8% per year, that total would be around £115,000. And that’s how much my compound returns could get me from a single year’s ISA investment.
Balance the risks
The approach isn’t risk-free. And the great ISA returns of the past decade really don’t tell us what the future might hold. So I’d balance the risk by spreading my cash across a range of dividend stocks in different sectors.
Which others might I buy? Well, Legal & General is on a forecast 8.6% dividend. Then there’s Taylor Wimpey at 9.3%, and British American Tobacco on 8.8%.
Those are forecasts and not guaranteed. But I’d say they’re on the way to building a diversified set of stocks. And a second income from dividends has got to be better than working for it, don’t you think?
