Who wouldn’t want a second income that we don’t have to work for?
I’m going for a Stocks and Shares ISA to try to do it. And my way is to buy stocks that pay good dividends.
And then I’ll reinvest my dividends every year to build up an ever-growing pot.
To get an idea what kind of pot I could manage, I need to work out what annual return I might get.
ISA millionaires
There are more than 4,000 ISA millionaires in the UK right now. And the great majority of them have done it with a Stocks and Shares ISA.
Many owe their success to buying to- quality dividend shares.
Not every year will be a success, mind. But the UK stock market’s long-term average has beaten other forms of investment.
So, what about the kind of dividends I’ll need to get me a decent second income?
Reduce risk
There are some big ones out there now, but I have one main caution.
I don’t want to put all my money into one sector that’s paying the most cash, because that’s too risky. I’d hate to have been mostly in banks when the financial crisis hit.
So, I try to pick from a range of sectors to give me some diversification.
And starting now, I might split my ISA money between M&G, British American Tobacco, Aviva, Lloyds Banking Group, and National Grid.
Nice return
If I could use my full £20k ISA allowance, that would be £4k per stock. And my average dividend yield, based on forecasts, would come in at 7.7%.
That would beat even the best Cash ISAs today, when interest rates are super high.
But I might go for £2k per stock and pick 10 instead. So I might add Taylor Wimpey, Glencore, Land Securities, DS Smith and BT Group.
From those 10 stocks, my overall forecast yield would still come in at 7.3%. So it’s not a lot less, for much better diversification.
10 years
If I could keep doing that with £20k every year, my calculations suggest I could have a pot of £290k after 10 years. And that would get me £21,260 per year in dividend income at my 7.3%.
This does assume the same dividend yields each year, which is sure not to happen. There’ll be ups and downs. And some years will probably even lose money.
Stock and Shares ISAs lost an average 13% in 2019-20, for example. But the average total ISA return over the past 10 years has been 9.6%.
More safety?
Now, dividend returns like this are far from guaranteed. And I might go for lower yields but better cover by earnings in order to reduce my risk.
And it’s definitely for the long term. I wouldn’t invest in a Stocks and Shares ISA unless I could commit to at least 10 years.
Of course, to get maximum returns I’d have to never deviate from reinvesting all my dividends.
But that’s easy, and I’d never be tempted to keep some back for a holiday or some other treat. Well, hardly ever.
