Making a second income from stocks isn’t a pipe dream. I do, and I know of plenty of other investors that do the same. However, for an investor that’s starting from scratch with an empty Stocks and Shares ISA, there’s some work that needs to be done in order to try and build the dividends to the point of making £650 a month.
Making use of the ISA
To begin with, the ISA needs to be set up. It’s possible to build a second income without one, but holding the stocks within this investment account is more tax efficient. When an investor receives a dividend or sells a stock for a profit, the proceeds aren’t subject to tax in the ISA. This means that more of the money can be retained, thus accelerating the process of building the portfolio.
In terms of funding the account, there’s a limit of £20k a year that can be invested in an ISA. Some might find it easier on cash flow to invest an amount each month, rather than adding £20k once a year. Of course, no one’s forced to invest £20k. But the closer an investor can get to this figure helps to speed up the process.
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.
Dividend stock picks
With the money ready to be deployed, the focus now turns to picking good dividend stocks. As a note, picking the stock with the highest yield isn’t always the best one. A high yield could be due to the share price falling, meaning that the dividend might not be sustainable.
Rather, considering a slightly lower-yielding option can be more realistic. For example, the abrdn Equity Income Trust (LSE:AEI). The investment trust has a dividend yield of 7.25%, with the share price up 5% over the last year.
The investment manager (abrdn) aims to provide a high income level by selecting a host of different stocks that pay dividends. It’s a nice option to consider as it takes a lot of the legwork out of researching individual ideas, as well as reducing hassle and transaction costs from buying all the stocks individually.
At the moment, the company has most of the exposure to UK shares. The largest weighting is to financial services with 43%, followed by energy at 18%. The biggest individual holding is Imperial Brands.
One risk here is that it’s an all-or-nothing-style trust. If an investor doesn’t like some of the holdings, they can’t pick and choose what the investment manager includes in the trust.
Reaching the goal
To make £650 a month, it’s not something that will happen overnight. Assuming that an investor can invest £20k a year with a portfolio of stocks that have an average yield of 7%, I can work out some forecasts.
After four years, the investment pot could be worth £115.5k. This could mean in the following year, it could generate a second income of £674 a month.
If an investor put in less per month, the time frame would become longer to hit the goal. Of course, these are just forecasts and should be taken with a pinch of salt, but it shows the potential!
