With no savings, here’s how I’d invest £16,000 in an ISA to aim for a £34,970 second income

Earning a second income from the stock market doesn’t require huge savings. Stephen Wright shows how he’d start from scratch this financial year.

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Investing in the stock market doesn’t require huge savings. Using part of my monthly salary to buy shares in profitable businesses could be a great way of generating a second income.

The results of investing regularly over time can be surprisingly impressive. And doing that through a Stocks and Shares ISA can help provide an additional boost with protection from dividend tax.

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.

Why use an ISA?

As a basic rate taxpayer, I’m required to pay tax at 8.75% on any dividends I earn above a £500 threshold. But this doesn’t apply to investments held in a Stocks and Shares ISA – they’re exempt.

Ordinarily, if I earn £2,000 in dividends this year I’ll have to pay £131.25 in taxes. That’s effectively 6.56% of my investment income and the equation gets worse the more I earn.

On £8,000 of distributions, I’d pay £656.25 – equivalent to 8.2% of my returns. Using an ISA to exempt myself from this and retain more of my investment returns makes a lot of sense.

The limit for investing through an ISA is £20,000 a year. But I’m planning on using £4,000 in my Lifetime ISA, so that leaves me with a limit of £16,000 for my Stocks and Shares ISA.

Aiming for £16,000

I’m always looking to reach my ISA contribution limit each year. And one way of getting to £16,000 is by investing £1,333 a month.

There are actually some benefits to this approach over investing the full amount immediately. One is that it doesn’t necessarily require any savings – I could fund my investments using my salary.

Another is that it’s hard to predict when the best time to invest this year will be. Share prices can be volatile, but doing so regularly increases the chances of investing when stocks are at their lowest. 

Even if I don’t manage to reach the full £16,000, anything I do invest can help build that second income. Obviously though, it’s important to be investing in the right places.

Getting started

Figuring out which stocks to buy can be tricky, even for the most experienced investors. But if I were building a second income, I’d start by using £1,333 to buy 26 shares in Unilever (LSE:ULVR).

With companies that look to rely on strong brands, there’s always a risk of customers trading down to cheaper alternatives. This is especially true when the cost of living has been rising.

Nonetheless, people have to eat, clean, and look after themselves in any economy. And Unilever has some advantages that make it hard for rivals to compete despite low switching costs for consumers.

These include the company’s size and its entrenched relationship with retailers. Smaller rivals aren’t able to emulate these easily and I expect them to lead to good returns for investors going forward.

Passive income

Unilever distributes around 67% of its net income to shareholders and those payments have been increasing steadily. And at today’s prices, that’s a dividend yield of just under 4%.

I said investing regularly can generate a surprisingly good second income. A 4% average return on £1,333 a month amounts to £7,264 after 10 years, £18,435 after 20 years, and £34,970 after 30 years.

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.

Stephen Wright has positions in Unilever Plc. The Motley Fool UK has recommended Unilever Plc. 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.

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