There are several ways to earn a second income. Some approaches include investing in buy-to-let properties, securing interest on cash savings accounts, or — for more creative souls — earning royalties from writing books or songs. Personally, I like to buy dividend stocks that distribute regular payments to shareholders.
One investor who’s made a huge success of this strategy is Warren Buffett. In 2022, his company, Berkshire Hathaway, received $704m in dividend income from its stake in Coca-Cola. That equates to a 54% yearly return in dividends alone on the billionaire’s original $1.3bn investment!
So, is it possible to generate £10,000 in annual passive income from a £20,000 investment in a Stocks and Shares ISA? Yes, I believe so. But, to secure this amount in dividends demands patience.
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Currently, the FTSE 100 index offers an average 3.77% dividend yield. By concentrating my portfolio in high-yield dividend shares, I could aim for more passive income from my portfolio. For instance, the following companies offer higher yields than the Footsie average.
- British American Tobacco — 8.7%
- Lloyds — 5.4%
- National Grid — 5.3%
- Taylor Wimpey — 9.1%
- Tesco — 4.3%
If I secured a 5.5% dividend yield across my ISA holdings, I’d need a portfolio worth just shy of £182,000 to produce a second income of £10k a year.
Let’s suppose I made full use of my £20k ISA limit this tax year. If my investments grew at a 10% compound annual growth rate (from dividend reinvestments and capital appreciation) I’d reach my target in just over 22 years.
…or over time
Of course, not every investor can afford to make a £20k contribution all at once. It’s still possible to generate a £10k second income by making smaller, regular investments over time — but this requires a longer time horizon.
To illustrate this, here’s how long it would take me to achieve my £182k portfolio goal depending on how much I could afford to invest per year until I hit £20k in contributions.
| Annual investment | Time taken |
|---|---|
| £5,000 | 24 years, 8 months |
| £4,000 | 25 years, 1 month |
| £3,333 | 26 years, 1 month |
| £2,000 | 27 years, 4 months |
| £1,000 | 31 years, 2 months |
It’s worth clarifying that this illustration assumes I’d only contribute £20k in total. In essence, the table shows the calculations that flow from an investment of £5k per year for four years, or £4k per year for five years and so forth.
An investor’s ISA allowance is renewed every tax year, so it’s not a £20k lifetime allowance, but rather an annual contribution limit.
Investing risks
Buying dividend shares isn’t a guaranteed way to make money. If my stocks performed poorly, a 10% compound annual growth rate would be too optimistic. Accordingly, my journey to a £10k second income could potentially take much longer than expected.
In addition, companies can get into financial trouble, leading to dividends being cut or canceled. This would eliminate or reduce my portfolio’s yield. This is especially true for some high-yield stocks, which often carry greater risks of dividend cuts.
However, with proper due diligence and a diversified portfolio, these risks can be mitigated. I believe there are substantial merits to dividend investing, despite the potential pitfalls. It remains my favourite way to build a sizeable second income over time.
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.
