1 ISA, £20k, and 3 stocks. Is this the perfect recipe for a second income of £1,420 a year?

With plenty of high-yielding FTSE 100 shares to choose from, now looks like a good time to start generating a healthy second income.

| More on:
A mixed ethnicity couple shopping for food in a supermarket

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The principal advantage of a Stocks and Shares ISA is that it’s possible to invest £20,000 every year and earn a second income that’s tax free. And HMRC won’t be interested in any capital gains either.

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.

If I was in a position to invest, I’d pick three FTSE 100 dividend stocks to help boost my income.

According to AJ Bell, the Footsie is currently yielding 3.9%. But there are five stocks in the index that don’t pay any dividends. And there are many more that offer relatively low returns for shareholders. It’s therefore possible to beat the average.

However, I wouldn’t necessarily choose the highest-yielding shares. A very large yield could be an indication that investors think the present payout is unsustainable. Instead, I’m going to look at those stocks that pay reliable dividends.

Slow and steady

National Grid (LSE:NG.) last cut its dividend in 1996. Its monopoly status in its key electricity and gas markets means it has stable and predictable earnings. And as long as it invests enough to keep the lights on, regulators will leave it alone.

The company aims to increase its dividend each year in line with CPIH, which is inflation including housing costs. Between now and 2026, it hopes to grow earnings per share by 6%-8% per annum. With CPIH currently at 3.8% — and falling — the company should be able to comfortably meet its dividend growth target. A payout of 60p over the next 12 months appears affordable to me.

One negative is that the company has borrowed heavily to fund its infrastructure investment. But although it has a mountain of debt on its balance sheet — £44.8bn at 30 September 2023 — 79% of it carries a fixed rate of interest, giving it a high degree of certainty about its interest payments.

The downside of owning a stake in a regulated business is that its share price is unlikely to grow spectacularly. Indeed, since March 2019, it has risen by 23%. And a change of government could result in a tougher regulatory regime — and lower earnings.

But I think it’s the sort of company that’s unlikely to deliver any surprises, which makes it ideal for an income investor like me.

Other stocks

My next choice would be HSBC. Although most economists believe interest rates are currently at their peak, analysts are expecting the bank to report healthy post-tax profits over the next three years — $27.9bn (2024), $22.9bn (2025), and $22.8bn (2026).

The bank plans to return 50% to shareholders via dividends. Analysts are predicting earnings per share of $1.40 in 2024. I’d therefore expect to receive $0.70 (55.4p). This excludes a payment of $0.21 that’s due when HSBC Canada is sold.

Finally, I’d pick Taylor Wimpey. I think the green shoots of a recovery in the housing market are starting to appear. And despite the recent downturn, it’s been able to increase its dividend for the past four years. Even though analysts are expecting a 4% drop in 2024, a payment of 9.2p implies a yield of 6.5%

Dividing £20,000 equally between these three stocks could give me a second income of £1,420 a year – a current yield of 7.1%.

Of course, dividends are never guaranteed. And I’d need to do more research before committing to buying all three. But this theoretical exercise illustrates how it’s possible to generate a decent tax-free second income.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. James Beard has positions in HSBC Holdings. The Motley Fool UK has recommended Aj Bell Plc and HSBC Holdings. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Elevated view over city of London skyline
Investing Articles

I’m considering shares in this FTSE 250 investment trust while it’s trading at a discount

With this FTSE 250 investment trust trading at a discount to NAV, this Fool thinks it's a bargain. Not to…

Read more »

Investing Articles

If I’d invested £1,000 in Tesla stock a decade ago, here’s what I’d have now!

While many of us debate whether Tesla stock is worth the price today, it's undeniable that the EV share has…

Read more »

Investing Articles

Here’s what Michael Burry did as the BP share price dipped!

The BP share price has fallen from its peaks once again, and infamous investor Michael Burry may have spotted an…

Read more »

Young mixed-race woman jumping for joy in a park with confetti falling around her
Investing Articles

What on earth’s going on with the Barclays share price?

The Barclays share price has skyrocketed in recent months, becoming one of the best-performing stocks on the FTSE 100 since…

Read more »

Man writing 'now' having crossed out 'later', 'tomorrow' and 'next week'
Investing Articles

Analysts say this amazing FTSE 100 stock is a takeover target!

This FTSE 100 stock's one of the worst-performing companies on the index in 2024. So why might other companies want…

Read more »

happy senior couple using a laptop in their living room to look at their financial budgets
Investing Articles

5.4% yield! 2 UK dividend shares to consider for a £1,080 passive income

I think these UK shares could provide a large and sustainable passive income. And they could be great buys today…

Read more »

Investing Articles

Here’s how investing £250 a month could bag me over £10K in passive income annually

This Fool breaks down how she would go about building a passive income stream worth over £10,000 annually to enjoy…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

I’d snap this FTSE 250 stock up in a heartbeat for juicy returns and growth!

Sumayya Mansoor explains why this FTSE 250 property stock is firmly on her radar as she looks to buy stocks…

Read more »