Starting from zero toward any goal is often the hardest part. The same applies when it comes to opening a Stocks and Shares ISA. The benefits are clear, mainly in the form of the exemption from capital gains and dividend tax. However, it can be a daunting prospect once opened to then figure out how to populate it with the aim of making a second income from investments. Here’s how I’d go about it.
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.
Strategy first, money second
Before I start thinking about monetary values, I need to compute a sound investment strategy. With my aim being to generate income, I need to focus on stocks that’ll help me achieve this.
For example, a good place to start is ranking stocks by the current dividend yield. This is a measure that calculates the yield of a stock, as a percentage, by comparing the dividend per share against the share price.
Clearly, the higher the better. However, I do need to watch out for unusually high-yield shares, as sometimes these can be a red flag over how sustainable the dividend is.
Within the FTSE 100, I like ideas such as Aviva (7.67%), NatWest Group (5.35%), and Kingfisher (5.10%). Investing in these stocks can help to build my ISA up from £0. I should note that dividend income isn’t guaranteed. But if the business does well and future dividends get distributed, it’ll serve as income for me.
Don’t forget growth stocks
Dividends are a good way to grow my ISA pot, but I shouldn’t discount growth stocks. This might seem odd, given that growth stocks tend to reinvest profits instead of paying out dividends. Yet the point here is that over time, I’d expect the share price to shoot higher.
This should mean that however much money I invest, I would see a profit in years to come. Given that I’m a long-term investor, this can work in my favour for income. Let’s say I invest £500 in a stock that rallies 50% over the next five years. My initial capital would be worth £750.
I could then sell £250 worth, realising this profit but leaving my initial £500 to hopefully grow even more.
The risk here is that I’m at the mercy of the market. If the company underperforms or we hit a recession, I might not have any profits to trim at all.
Hitting £10k annual income
To build up to £10k in annual income, I’m going to assume that my pot grows at a rate of 8% per year. This might seem high, but I’m basing this off an average dividend yield of 6% from income stocks and 10% gains from growth stocks.
If I invest £450 a month, it’ll take me 13 years to reach my goal. This might seem a long time, but remember this is starting from £0. Thanks to the tax benefits of the ISA, it takes less time doing it this way than if I built the pot outside of it!
