The median annual pay for full-time workers in the UK was about £35k last year, according to Statista. So, securing a second income of £50k would make a huge difference for most people, even when considering that inflation will reduce future spending power.
Here are four straightforward steps to try and achieve this goal through the stock market.
Think long term
Billionaire investor Warren Buffett once said: “If you buy things you do not need, soon you will have to sell things you need.”
Of course, this is a warning about the dangers of impulsive spending. In the stock market, impulsivity can lead to very rash decisions and severely harm returns.
I think one way to help counter this is by fostering a long-term mindset. Rome wasn’t built in a day and neither is wealth for most people.
Trading in and out of stocks is the epitome of short-termism. I try to avoid doing this.
Open an ISA
We’re blessed in the UK to have the Stocks and Shares ISA. This allows anyone to invest up to £20k a year in stocks and pay no tax on any returns made.
Therefore, an ISA would be my chosen vehicle to aim for a tax-free second income over the long run.
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.
Focus on quality
There are a few different styles of active investing and all can be successful. Here are three main ones.
- Value investing involves finding stocks that are potentially undervalued
- Growth investing focuses on companies displaying above-average growth
- Dividend investing involves finding companies that pay regular dividends
A fourth style I’d highlight is ‘quality’ investing. This involves putting money behind top-quality businesses trading at reasonable valuations, specifically those with high levels of profitability and huge competitive advantages.
A perfect example would be payments processor Visa (NYSE: V). The company takes a small cut of every transaction flowing through its network. Considering there are now more than 4.4bn Visa cards globally — roughly one card for every two people on Earth — that adds up to a lot.
And due to its established and sprawling global network, Visa’s profit margin is a staggering 53%!
Moreover, its fees are percentage-based, which offers a hedge against inflation. This is because as the prices of goods increase, the value of each transaction also rises, helping the firm’s earnings keep pace with inflation.
The flip side to that, of course, is that high inflation and economic downturns often result in consumers spending less, which isn’t great for Visa. So a severe global recession is always one risk to keep in mind.
Still, the growing preference towards digital payments over cash goes on, presenting a decades-long runway of growth, especially in emerging markets. Consequently, Wall Street sees Visa’s earnings rising in the low double-digits over the next few years.
Finally, the stock is trading at a reasonable 26 times forward earnings — slightly below its five-year average.
Let time do its thing
I think it’s entirely realistic to aim for an average 8% annual return from a diverse portfolio of quality stocks like this.
If I can achieve this, then investing £850 a month would compound into £845,437 after 26 years (with dividends reinvested).
At this point, I’d be generating just over £50k in dividends if my portfolio were yielding 6% a year.
