Investing in a Stocks and Shares ISA can be a great way to build a second income stream for retirement.
By regularly investing and letting compound growth work its magic, even relatively modest monthly sums can add up to a sizeable pot.
While it’s never too late to start, it’s definitely better to begin early. That gives more time for compound interest to work its magic.
Let’s say a 40-year-old has only just woken up to the attractions of investing in an ISA, and can afford to put away £500 a month.
Now let’s assume they stick at it for 25 years, and their portfolio grows at an average annual rate of 7%, in line with the long-term FTSE 100 average total return. They could build a nest egg of £406,059 by the time they turn 65.
FTSE 100 dividends can fund a retirement
If they upped their monthly payments as their income increased, and threw in lump sums when they had cash to hand, they could end up with a lot more than that.
Now, let’s say their portfolio generated an annual yield of 6%. That’s above the FTSE 100 average yield of 3.5%, but is doable by targeting stocks that pay above average dividends.
On a £406,059 pot, they’d generate an impressive £24,364 a year, without touching their capital. That’s more than £2,000 a month in passive income.
Crucially, their capital remains intact, meaning they could continue drawing income for decades. Or take lump sums too.
Right now, there are plenty of top dividend stocks to choose from. National Grid (LSE: NG.) is a favourite among income investors.
As a regulated utility, it delivers essential electricity and gas services across the UK and parts of the US.
This stable business model allows it to generate reliable cash flow, which in turn supports a steady dividend payout. Right now, the stock has a trailing dividend yield of 6.3%.
As with every stock, there are risks. National Grid is investing heavily in the transition to green energy, which requires substantial capital expenditure. We’re looking at £60bn in the next five years.
Even National Grid shares carry risk
Last year, it even asked shareholders for more money through a rights issue. This uncertainty has weighed on the stock, which is down 4% over the last year and flat over five.
Yet it looks unusually good value by its own standards, currently trading at just 10 times earnings. That could make now an interesting entry point to consider for long-term investors looking to lock in a high yield.
Relying on a single stock would be risky. Our hypothetical 40-year-old investor should aim to build a diversified portfolio of around 15 different shares. This would help spread risk, balance income and offer more capital growth potential.
By focusing on high-yield dividend stocks like National Grid and maintaining a well-diversified portfolio, investors could set themselves up for a comfortable and secure retirement.
History suggests the stock market should deliver a far superior return to cash over time, but with volatility along the way. We’re seeing some of that volatility right now. This actually favours investors who pay in regular monthly sums, as their contribution buys more shares when markets are down. The ISA deadline is fast approaching. Time to get stuck in.
