Creating a second income is a common goal these days. With an additional source of cash flow, one has far more financial security.
The good news is that this financial goal is very achievable. With that in mind, here’s a look at how I’d aim to build up a £10k per year second income within an ISA.
Passive income from dividend stocks
One of the easiest ways to generate extra income today is to invest in dividend stocks. With these stocks – which can be bought in a Stocks and Shares ISA – investors receive regular cash payments (the companies’ profits are distributed to shareholders).
Now, the yields on dividend stocks vary. For example, consumer goods company Unilever currently offers a yield of around 3.8% (meaning a £1k investment would generate around £38 in income per year). However, insurance and investment management firm Legal & General Group currently sports a yield of 9.5% (a £1k investment would deliver annual income of £95).
How much money I’d need to create £10k in income from dividend stocks would depend on the overall yield I was able to achieve from my portfolio. For instance, if I was able to achieve an average yield of 5% across the portfolio, I’d need £200,000 to generate £10k. Yet if I was able to generate a yield of 7%, I’d only require about £143k in capital.
Building the capital required
Let’s say I was able to obtain an average yield of 6% from a portfolio of dividend stocks in the future. In this scenario, I’d require about £167k to generate income of £10k.
Now, I don’t have a spare £167k lying around right now. And even if I did, I wouldn’t be able to dump it into an ISA all at once as the annual allowance is currently only £20k.
But with a regular savings and investment plan, I could build up this amount of capital over time.
Here, there are several approaches I could pursue.
I could simply invest in dividend stocks from the start. By making regular contributions to my ISA, investing in dividend-paying companies, and reinvesting all of my income, I could compound my way to the £167k mark.
Alternatively, I could invest in growth stocks now and then shift my capital into dividend stocks when my portfolio was worth £167k. With this approach, I could potentially hit the £167k mark faster as growth stocks tend to provide higher returns than income stocks over the long term (growth stocks are more volatile, however).
For example, if I was to get on to a stock like chip designer Nvidia, which has risen more than 500% over the last five years, I could hit my goal much faster.
Of course, I could combine these two strategies. This could be the best approach. This would allow me to start compounding my dividends now, while also giving me the opportunity to generate some high returns in my portfolio.
