I’d aim to turn a £20k ISA into a £21,366 passive income with FTSE 250 shares!

Many Stocks and Shares ISA investors have made fortunes by buying FTSE 100 and FTSE 250 shares. Here’s how I plan to follow their lead and retire in comfort.

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I think Stocks and Shares ISAs are great ways to build long-term wealth. I’m using one to build a winning portfolio dominated by FTSE 100 and FTSE 250 shares.

Buying UK shares in one of these tax-efficient products could potentially provide me with an awesome passive income in retirement. Let me show you how.

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.

Passive income stocks: our picks

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The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

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Good, not great

I’m not going to say that cash accounts are useless financial instruments. I use an easy-access Cash ISA to store cash for a rainy day. These products are also a great way for me to manage risk — I know that any money I invest here will still be there 5, 10, 50 years from now.

The same can’t be said for investing in stocks, cryptocurrencies, commodities, or any other asset that’s subject to market forces.

However, this security comes at a price of much poorer returns, a problem that could have a significant impact on my retirement income.

Today, the best-paying, instant-access Cash ISA (from Harpenden Building Society) provides an annual interest rate of 5.01%. Here’s how my retirement pot would look after 30 years if I invested £20,000 in one of these today.

Timescale5.01%
Starting sum £20,000
5 years £25,680
10 years  £32,973
20 years  £54,361
30 years  £89,622

Better returns with FTSE 250 shares

That £89,622 I could make doesn’t look too bad at first glance. But, critically, it assumes the 5.01% rate will remain the same over the next three decades, which is a big assumption to make.

What’s more, the wealth I could have made with that Cash ISA pales in comparison with what I could have made by holding FTSE 250 shares in a Stocks and Shares ISA instead.

Since its inception in 1992, the FTSE 250 has delivered an average yearly return of 11%. This is what a £20k investment would turn into after 30 years if this long-term trend continues.

Timescale11%
Starting sum £20,000
5 years £34,578
10 years £59,783
20 years £178,700
30 years £534,162

As one can see, that 11% return would make me almost six times as much cash after 30 years than that 5.01%.

And if I drew down 4% of this £534,162 a year, I could enjoy a healthy £21,366 passive income for around 30 years before my cash ran out.

An ISA investing strategy

Past performance is no guarantee of future returns. But building a diversified portfolio of FTSE 250 shares could give me a good chance of making a big second income when I retire.

One strategy I’m using is to buy well-established companies that can grow earnings ahead of the broader market. One such example is Britvic (LSE:BVIC), the drinks manufacturer that sells iconic brands such as Robinsons, Pepsi Max and Lipton in several markets including the UK, Brazil and France.

Stable demand for these drinks gives the company excellent earnings visibility over the long term. Meanwhile, its broad geographic footprint and position in multiple categories (including soft drinks, water and energy drinks) gives it extra stability.

Supplementing shares like this with high-dividend, high-growth companies adds risk. But this would also enable me to potentially make greater returns over the long term. And by buying a selection of different companies (say five to 10) I can greatly reduce this risk.

Pound coins for sale — 31 pence?

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Britvic Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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