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.
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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.
