By my calculation, I could invest £200 a month via my ISA to target for a chunky second income. I’d aim to withdraw this income year after year, and with a fair wind, it wouldn’t even eat into the nest egg I’d built up.
Before I pick apart the nuts and bolts of that calculation, let’s look at how I’d do it. Because this process follows a particular investing style that’s sometimes unloved and certainly isn’t for everyone, but starts with the crucial Stocks and Shares ISA.
Snowballing
The Financial Times called ISAs “arguably the best investment ‘wrapper’ in the Western world” and I’d have to say I agree.
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I can deposit up to £20k a year and I avoid punishing taxes on interest, capital gains or dividends. That means I can use my ISA to build an income – perhaps as dividend payments – and I never pay any tax or charges on the withdrawals. That’s for the rest of my life, by the way, and these accounts have no upper limit either.
The tax benefits of ISAs are perhaps even too good, and Rishi Sunak has faced calls to alter them. Let’s hope it doesn’t come to that – these accounts benefit even modest savers – but it makes sense that I make the most of my ISA allowance while I still can.
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.
I’d aim for a 10% yearly return. The returns might seem minuscule at the start – the first £200 I invest would receive £20 over a year – and I wouldn’t blame anyone who wonders what the point is. But this strategy doesn’t rely on lightning-fast returns. Rather, it’s quite boring and slow.
After 30 years, that first £200 has compounded and grown all the way up to £3,489. That original sum is up 17 times in value all from small percentage returns over a long time.
Growth like this is sometimes called ‘snowballing’ as it resembles a snowball that rolls and slowly gets bigger. This type of accumulation is what my second income would be built on. But I have to say there are no guarantees and I could achieve a lot less than 10%.
How it works
I need to make high-quality investments to ensure every pound I invest is working for me. My 10% return target is close to historical averages. But poor investing or a stagnant economy might make that an unfeasible goal.
With the risks in mind, let’s move to the exciting part. Let’s say I invest the £200 every single month for 30 years. Each amount snowballing throughout, by the end it could have compounded into a nest egg of £415,859.
As satisfying as growing my net worth may be, I would stop the snowballing and start withdrawing at some point. After all, I can’t take it with me. If I chose the 30-year mark to withdraw some cash, then I could take out 4% to get an income of £16,634 each year.
The 4% drawdown rate is deliberately lower than the 10% target return. A modest withdrawal offers more safety in the event of a bad year or two, so I have more chance of keeping my cash pot intact. I may even have a substantial amount to leave behind for loved ones as well.
