How I’d invest for a second income using my £20k ISA allowance

Here’s a three-strand investing strategy and some stock ideas for building a second income portfolio starting with £20k in an ISA.

| More on:
Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper

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.

With my £20k ISA allowance (that is, my contribution limit), I’d invest in shares and build a growing dividend stream to finance a second income.

My approach would have three strands. First, I’d look for stocks with a chunky dividend yield now.

Big-dividend stocks would give me a decent-sized cash income stream sooner rather than later. The money would give me choices. For example, I could draw it for a second income, or reinvest it to help build up the share account so it’s capable of paying an even bigger income later.

The power of growth

A second strand would be to look for companies that have a good rate of dividend growth. Dividends are good, but an income stream that gets bigger over time can be even better.

The progress a company makes with dividend payments often reflects the success and growth of the underling business. That means a decent dividend-grower can often deliver its shareholders a rising share price too.

The third strand would be to ignore dividends and focus just on the growth of an enterprise. Often, fast-growing businesses don’t pay dividends, or pay tiny ones. Instead, they tend to reinvest their cash flow back into operations to generate even more growth.

If the capital value of my portfolio is rising, I can choose later how to use the gains to generate a second income. I could draw money directly from the portfolio by selling shares, for example. Or I could reinvest the money into big-dividend-paying stocks or dividend growers.

For my big-dividend stocks, I’d consider names such as Legal & General, Renewable Infrastructure, MONY Group and others. Meanwhile, for my dividend-growers I’d target companies like RELX, BAE Systems, Halma, DCC and similar.

For growth, I’d tend to consider smaller companies with a long runway ahead. Names on my watchlist now include ME International, Gamma Communications, Wilmington and Spectra Systems (LSE: SPSY), which deals in machine-readable, high-speed banknote authentication, brand protection technologies, and gaming security software.

Trading well and a robust outlook

At the end of September, the company delivered a strong set of half-year results and a positive outlook statement. Meanwhile, City analysts expect normalised earnings to increase by a whopping 70% this year and 110% in 2025.

With the share price in the ballpark of 246p, it’s been adjusting to the progress of the business and stair-stepping higher.

However, with such big anticipated earnings increases, one risk for shareholders is the business may fail to keep up its rate of growth, perhaps because of not winning contracts it’s pitched for. It could even miss current estimates. If that happens, the valuation could be left ‘stranded’ at too high a level.

For the time being though, the forward-looking earnings multiple is just over seven for 2025 when set against the forecast. However, Spectra Systems is a FTSE AIM-listed small-cap stock with a market capitalisation of just £117m. So, although the multiple looks undemanding at first glance, I’d expect it to be lower than some because of the risks that come with smaller businesses.

Nevertheless, despite the uncertainties, I’d conduct further research and consider the stock now for inclusion in a portfolio financed by my £20k ISA allowance.

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.

Kevin Godbold has no position in any of the shares mentioned. The Motley Fool UK has recommended BAE Systems, Gamma Communications Plc, Halma Plc, Mony Group Plc, RELX, and Wilmington 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.

More on Investing Articles

Shot of a senior man drinking coffee and looking thoughtfully out of a window
Dividend Shares

How much passive income could I generate with just £10 per day?

Ken Hall wants to create his £10,000 yearly passive income dream by investing just £10 every weekday day in Footsie…

Read more »

Investing Articles

Is the Rolls-Royce share price too high? Here’s what the experts say

The Rolls-Royce share price has surged over two years, representing one of the FTSE 100’s greatest success stories. But is…

Read more »

Smart young brown businesswoman working from home on a laptop
Investing Articles

A top S&P 500 growth share and an ETF I’d buy this November!

I think this S&P 500 share and exchange-traded fund (ETF) could be brilliant additions to my ISA or SIPP right…

Read more »

US Stock

Here are the best-performing S&P 500 stocks after the US election result

Jon Smith notes some of the largest gainers from the S&P 500 yesterday and explains how the election result has…

Read more »

Growth Shares

2 UK stocks knocking on the door of promotion to the FTSE 100

Jon Smith points out a couple of UK stocks that he feels could be ready for the big league based…

Read more »

Investing Articles

Rolls-Royce shares just fell 7%. Is it time to buy?

This investor in Rolls-Royce shares takes a look at the FTSE 100 engine maker's trading update to see what caused…

Read more »

Young Black woman looking concerned while in front of her laptop
Investing Articles

What’s going on with the Auto Trader share price?

Paul Summers takes a closer look at why the Auto Trader share price has tumbled despite the company posting higher…

Read more »

Investing Articles

Legal & General shares look set to give me a mind-blowing 10.22% yield in 2026!

Harvey Jones is getting a brilliant second income from his Legal & General shares and expects even more to come.…

Read more »