Building a portfolio of UK stocks is a great way to generate a second income for retirement. That’s what I’m doing anyway.
Investing through a tax-free Stocks and Shares ISA means this income remains tax-free for life. However, accumulating enough for a comfortable retirement isn’t an overnight job. It takes years. Decades. Time is an investor’s greatest asset, making it especially beneficial for those in their 20s and 30s.
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.
Investing in FTSE 100 shares for income
The longer money is invested, the more time any share price growth and dividend income has to compound.
If someone invests a £10,000 lump sum at age 30 and achieves an average total return of 7% a year after charges. That’s roughly in line with the historic FTSE 100 average.
By age 65, their £10k would have grown to £106,766. It will have increased more than tenfold.
Now let’s say they invest exactly the same sum but at age 40. Their £10k would grow to just £54,274. That’s just half as much.
Their investment term is 25% shorter, but their total return is 50% lower. The compounding effect is greatly diminished. This demonstrates how important it is to get started early.
Few 30-year-olds have £10,000 to invest upfront, so let’s assume they invest £250 a month instead, from income. If their ISA contributions grows at 7% annually, they’d pay in £105,000 over 35 years.
Growth could add £338,740, bringing the total value of their retirement pot to £443,740.
That’s a substantial sum. The income should help deliver a comfortable retirement, especially when combined with the State Pension and, say, a company pension.
Company dividends are so valuable
However, inflation will erode its true value over time, making it wise to increase contributions annually. Raising the monthly investment by 5% once a year instead of keeping it static would result in £828,271 by age 65. As with all these figures, this assume 7% annual compound growth.
Many investors underestimate the importance of dividends, the regular payments companies make to shareholders. Most companies aim to increase them every year, but payouts aren’t guaranteed. They can be cut or axed at any time.
Tobacco maker Imperial Brands (LSE: IMB) is a hugely popular FTSE 100 dividend stock and worth considering. It currently has a trailing dividend yield of 5.55% a year.
The shares have also done brilliantly over the last year, soaring 68%. Common sense suggests they will slow from here. No stock rockets forever.
However, Imperial Brands has a terrific track record of delivering both dividend income and share price growth, albeit with ups and downs along the way.
There are risks. Smoking is in decline and regulators aren’t going to leave it alone. The suggest revenues should slide over time.
Imperial Brands is fighting back by boosting share in the declining market. It’s also moving into e-cigarettes and vaping, to replace traditional methods of nicotine delivery.
To mitigate risks, it’s wise to invest in a diversified portfolio of 15 to 20 dividend and growth stocks. Starting as early as possible and investing consistently maximises the benefits of compound growth. Patience and discipline are key. Stick with it, and the rewards should follow.
