A Stocks and Shares ISA lets me put money away now and hopefully benefit from it working away quietly in the stock market over years to come. As a long-term investor, that suits me perfectly.
But while I could invest £20,000 each year in such an ISA, I may also try and do well putting a much more modest amount away on a regular basis.
In the example below, I use a monthly contribution of £100 and explain how – ultimately – I would aim to turn that into an annual tax-free second income of £9,525.
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.
Investing on a scale that suits me
Putting £100 a month into shares might not sound like the foundation of an investing fortune. But every investor is different and it is important to work within one’s own financial constraints.
If I put £100 away each month, I would have well over £1,000 a year to invest in my Stocks and Shares ISA.
Over the long run, between ongoing contributions and investing returns, that could potentially add up to a lot. So my first move would be to set up a Stocks and Shares ISA.
Saving, investing and compounding
But how could I turn those regular contributions into a second income of £9,525?
The answer comes from taking the long-term approach to investing I mentioned earlier.
By doing that, not only can I keep growing my invested capital by £100 a month, but hopefully the shares I own can increase in value over time (though whether they do depends on which shares I own and what I paid to buy them).
On top of that, if I can reinvest dividends I earn (something known as compounding), that could give me more money to invest, growing the overall value of my Stocks and Shares ISA.
By investing £100 each month and compounding at an average annual growth rate of 9%, I could be earning a second income of £9,525 after 25 years.
Finding shares to buy
Is a 9% compound annual growth rate achievable over the long term, through both bull and bear markets?
I believe it is. To target it, I would look for shares in great companies that I could buy at an attractive price. That could mean saving money in my ISA and waiting for the right shares to become available at a price I like, something that might take years.
An example of such a share I would consider buying for my ISA if I had spare cash to invest is Dunelm (LSE: DNLM).
Over the past five years, the prive has risen 40%. But that is not all. It has also been a solid dividend payer. Currently it yields 3.5%. On top of that the retailer has paid special dividends that are not included in that yield.
Past performance is not necessarily a guide to what will happen in future. A weak economy could hurt consumer demand, threatening non-essential homeware sales at Dunelm.
But with a large store network, growing digital presence and wide range of proprietary products, I think Dunelm has competitive advantages that could help keep it performing well in the long term.
