A second income is a great way to help fund a more comfortable retirement.
However, the average 45 to 55-year-old in the UK has only £20k (or less) in savings. Most people won’t be able to stretch that very far once they’ve retired. Withdrawing £2k a month would deplete those savings in less than two years.
Fortunately, there’s still time to save up £20k and convert it into a consistent and reliable second income stream.
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The ISA route
The first step to consider is a Stocks and Shares ISA, which allows investments of up to £20k a year tax-free. Investors can select whatever shares they want to include in the ISA and won’t be taxed on the returns.
There are several UK banks and financial institutions that offer a Stocks and Shares ISA, each with varying fees and features.
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.
Calculating returns
To figure out how to achieve £2k a month in returns, it’s necessary to calculate how an investment will compound over several years. This provides an idea of the type of shares that would need to be included in the ISA.
A well-balanced and diversified portfolio of shares typically returns between 5% and 10% a year. Returns can come from both share price appreciation and dividend payments. To benefit from both, it’s best to include a mix of dividend-paying shares and reliable, long-term growth shares.
Let’s consider an average dividend yield of 4% with an average price increase of 6% per year. By reinvesting dividend payments to further compound the returns, a £20k investment could reach £354,782 in 30 years. The annual 4% dividend payment would be £13,088 — just over £1,000 a month. Dividends aside, at this point a £2,000 monthly withdrawal would last 177 months, or almost 15 years.
However, by investing a further £150 per month throughout the 30 years, the investment could grow to £654,278. Then the 4% annual dividend payment would be £24,071 — over £2,000 a month. This amount could now be withdrawn monthly without reducing the overall value of the investment!
A share to consider
Scottish Mortgage Investment Trust (LSE:SMT) is a well-diversified mix of shares and investments, providing exposure to a range of popular companies in both the private and public sectors. Diversification makes it less susceptible to unforeseen events affecting specific industries or regions.
Despite the seemingly localised name, the Edinburgh-based investment also includes shares in popular foreign stocks like Tesla and Amazon. Although it’s down 40% since its peak in late 2021, it gained 31% in the past year and is up 64% over five years. This highlights the benefits of long-term investing.
However, some analysts feel the stock lost its shine after a management change in 2022. The share price fell since and was recently trading at a discount of 15% below the net asset value (NAV). On 15 March, Scottish Mortgage announced a £1bn buyback program, which has helped the share price increase 10% since. US hedge fund Elliot Investments bought a 5% stake in the firm — likely a strategic attempt to benefit from the discount.
Despite the recent struggles, Scottish Mortgage Investment Trust outshone the FTSE All-share index over the past year and now looks set for more growth. If I were formulating a second-income portfolio, I think it would make a great addition.
