Owning an ISA stuffed with high-quality dividend is one way to try and build a second income.
It can be a lucrative approach for someone who is willing to put in enough money and take a long-term approach.
Doing the maths
As an example, let’s work backwards from an annual second income target of £30,000.
Dividends are never guaranteed (that is why smart investors spread their risks by diversifying their portfolio). But at a simple level, annual income is a function of how much is invested and the dividend yield.
The yield is the annual dividend income expressed as a percentage of what the shares originally cost, which can be different to their current price.
So, for example, £300,000 invested at a 10% yield would generate an annual second income of £30,000. If the yield was 5%, the target would require a £600,000 portfolio.
That 5% is above the current FTSE 100 yield. I think it is realistic, though, in the current market to target a higher yield, of 7%. This is while sticking to blue-chip companies with proven business models.
Taking the long-term approach
Doing that, the annual second income target of £30,000 would require an investment of close to £429,000.
The good news is that investment can be built up over time. For example, say the investor opens a Stocks and Shares ISA today and invests £20,000 each year into it, compounding its value at 7% annually.
After 14 years, the portfolio should be worth more than £429,000. If it yields 7% at that size, it would then generate over £30,000 each year as a second income.
Being realistic – and taking action
So, although the second income requires a wait, I think 14 years is a reasonable time frame for such a goal.
After all, this is not some get-rich-quick scheme, but a serious effort to build an extra income stream through investing in carefully chosen quality companies.
I mentioned above that I see a 7% yield as realistic in today’s market.
One share I think investors eyeing a long-term second income ought to consider is FTSE 100 asset manager M&G (LSE: MNG).
It currently yields 7.9%. It also aims to grow its dividend per share annually and has done so over the past few years. Though, as I mentioned above, dividends are never guaranteed to last at any company.
I like M&G in part because the asset management industry is huge and long-term demand is resilient. With its strong brand and long experience, the company looks well-placed to capitalise on that over the long run. That helps explain why it has over 5m customers.
M&G has struggled in recent years to get clients to put more money in than they take out of its products. I see that as an ongoing risk to profitability.
In the first half, though, the company saw a net inflow of £2.1bn to business areas that are still open to investment. I see that as encouraging progress on this front.
