The dividends earned from the holdings in my Stocks and Shares ISA give me a reasonably healthy second income. Don’t get me wrong, it’s not enough for me to retire… yet. But there are plenty of years before I intend giving up work.
The beauty of holding my shares in this particular investment vehicle is that any income is earned free of tax. The same applies to any capital gains. In my opinion, this is the biggest single benefit of a Stocks and Shares ISA. All we need now is for stamp duty on the purchase of shares to be abolished. Are you listening, Rachel Reeves?
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.
The eighth wonder of the world
But I don’t spend this second income stream. I reinvest it. That way I can enjoy the benefits of compounding, which has been described as humankind’s greatest invention.
It’s a powerful concept.
For example, if an individual invested £5,000 every year for 30 years — and received dividends of 6% — they would generate a second income of £300 in year one, £600 in year two, and so on. After three decades, they could have an investment pot worth (ignoring any capital gains or losses) £150,000 and would have banked income of £139,500.
But reinvest the dividends and the ISA would be worth £419,008.
At this point, a 6% return would provide a second income of £25,140 a year or £2,095 a month. Remember, this ignores any movements in share prices (up or down).
A reasonable target
So, is it realistic to target a 6% return?
Well, the FTSE 100 (an index comprising the largest listed companies in the UK) is presently yielding 3.34%. But the average for the top 10 yielders is 6.9%. There are no guarantees when it comes to dividends but by shopping around and doing some careful research, I think it’s possible to achieve an above-average return.
However, if all goes well, a portfolio will also achieve some capital growth.
According to the London Stock Exchange, the five-year average annual return (with dividends reinvested) of the FTSE 100 is 13.9%. However, this period includes a strong post-pandemic recovery. From 2015-2024, the annual average gain was 6.75%.
Something to consider
One share that has a history of offering good capital growth with a reasonably generous dividend is Tesco (LSE:TSCO). Everyone has to eat, which means the stock has defensive properties.
Since October 2020, its share price has risen by an annual average of 10%.
And the stock is yielding 3.1%. If this blend of growth and income could continue, it would be possible to achieve a better return than the 6% referred to above. Of course, there are no certainties when it comes to investing.
Not least because the supermarket sector is highly competitive and margins are wafer thin. Tesco might also suffer from changes that are being contemplated to commercial rates. The government is rumoured to be exploring ways of shifting more of the burden to larger shops and premises.
However, Tesco has proved itself to be remarkably resilient. With a 28.4% market share, it remains Britain’s largest grocer and has recently upgraded its full-year profit guidance.
For these reasons I think the stock could be considered as part of a well-balanced diversified portfolio to help deliver a healthy second income.
