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Many investors dream of earning a second income, including me. But, for those at the outset of their investing journeys, it’s difficult to know how to get started.
There’s no right answer to that. Different strategies can produce heaps of passive income, albeit each carries its own risks. Personally, I’d buy dividend stocks in a Stocks and Shares ISA to target a £30k second income.
Here’s how.
Laying the foundations
There are several pitfalls that novice investors might encounter when they make their first foray into investing. It’s tempting to set unrealistic expectations of how long it takes to build serious wealth.
Day trading cryptocurrencies or unresearched penny stocks with the promise of spectacular overnight returns might sound appealing. But, there are huge risks in pursuing these endeavours, not least the potential for total loss of capital. I’m reminded of Aesop’s fable about the tortoise and the hare — slow and steady wins the race.
Accordingly, I’d make consistent, long-term investment choices instead. For investors who can afford it, there’s a £20k annual contribution limit for a Stocks and Shares ISA. By establishing regular savings targets and making wise choices, I wouldn’t let my precious tax-free pot go to waste by speculating on extremely risky bets.
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.
Building a dividend portfolio
That’s not to say dividend investing is risk-free. Far from it. Share prices are volatile, dividends can be cut or suspended, and stock market crashes can leave investors in the red for many years.
However, via diversification and adopting a long-term mindset, I can mitigate these risks to some extent. Moreover, I always carefully research any stocks on my watchlist before buying, so I understand the opportunities and challenges facing each company I invest in.
The bulk of my portfolio is concentrated in well-established firms with strong track records of profitability. The FTSE 100 and S&P 500 are great places to look for quality companies, many of which offer healthy dividend payouts. It’s possible to buy shares listed on these indexes in most ISAs.
Dividend stocks that currently feature in my portfolio include:
- British American Tobacco — 9.2% yield
- McDonald’s — 2.2% yield
- Tesco — 4.3% yield
Watching it grow
Earning a £30k second income takes time and discipline, but the power of compound returns can be dramatic if I reinvest my dividends and I’m prepared to wait before making withdrawals.
Let’s imagine I was able to invest just a quarter of my annual ISA allowance. That would equate to a little under £417 per month. If I secured a 4% dividend yield across my stocks, I’d need a portfolio worth £750k to earn £30k in dividends.
How long it would take me to get there depends on the compound annual growth rate (CAGR) of my portfolio.
| CAGR | Time taken |
|---|---|
| 4% | 49 years, 6 months |
| 6% | 39 years, 3 months |
| 8% | 33 years, 0 months |
| 10% | 28 years, 9 months |
As the table above illustrates, with well-chosen stocks and time on my side, I could be earning £30k in dividends in less than three decades!
However, prudent investors should always factor in the possiboility of weaker returns into their modelling. Nonetheless, the sooner I put my plan into action, the sooner I could be earning a chunky second income.
