A second income that we don’t have to work for — isn’t that a nice dream? On top of other income we might have in retirement, £1,000 per month could make a very nice addition.
I’m building a diversified collection of UK stocks in my Stocks and Shares ISA myself. However successful I am, I won’t have to pay tax when I withdraw money.
If I make a million, there won’t be a single penny to pay to the inland revenue. If I pick a few lemons along the way and don’t do so well? At least the tax-free nature of my second income will be a consolation.
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.
Stock market returns
Over the past 20 years, the FTSE 100 has produced an average annualised return of 6.9%. When we consider that period covers the banking crash, Brexit, the Covid pandemic… it shows UK companies can be remarkably resilient. And I reckon it can pay to be a part owner of a selection of them.
Starting out, it might sound hard to get it right. But you don’t have to pick your own individual stocks the way I do. There’s a straightforward way to get going.
It’s to buy a FTSE 100 index tracker fund, like the iShares Core FTSE 100 UCITS ETF (LSE: ISF). Big name, simple concept — it invests to try to match the index returns. It’s been doing well at it, with low tracking errors. And super low annual charges means we can hope to get very close.
What do we need?
To get to the £12,000 per year income we’re talking about, there are different approaches.
One is to assume the tracker produces the same 6.9% total annual return — and then take that all as income. Part of it comes from share price rises, so it would mean taking out some capital. But depending on what other income and investments we might have at the time, it can make sense.
An investment pot of around £174,000 would produce the needed income at that return. And someone who could invest £500 per month could get there in a bit over 16 years.
Preserve some capital
Another approach is to take out the equivalent of FTSE 100 dividends — the long-term average is close to 4% per year. And then keep the rest in the pot. Someone who goes for that would need a bit over £300,000, which is a lot of money. But at the rates we’re assuming here, it could still be achievable in 22 years.
For a lot of investors, even into their forties and beyond, that’s definitely a feasible timescale. And for younger people with 40 years or so of expected working lives ahead of them… well, the possibility of becoming an ISA millionaire by retirement is a real one.
Different courses
Things are different for everyone. Invest more for less time, smaller amounts for longer, whatever we can afford… the real secret is to try to maximise both. I think investors should diversify further as they gain experience — but the iShares tracker is a good one to consider for starting out.
