A reliable second income from an ISA is a goal most investors quietly work towards. And £600 a month is an ambitious but achievable target with the right strategy.
That level of income equates to £7,200 a year. Not huge, but tax-free and it would likely make a difference to most people in the UK.
So, how large a portfolio is needed to generate it sustainably?
The answer obviously depends heavily on the income yield produced by the investments held inside the ISA. For example, a portfolio yielding 4% annually would require around £180,000 to generate £7,200 per year. A higher 5% yield reduces the requirement to roughly £144,000. Meanwhile, a more cautious 3% yield would mean needing closer to £240,000.
And whether those yields are achievable depends on risk appetite and the market. Today, there are fewer companies with large yields than there were a fewer years ago. This is because the market is hotter and yields are inversely correlated with share prices.
Moreover, higher yields reduce the amount of money required upfront, but they often come with greater risk, less dependable payouts, or lower long-term growth. Chasing the highest income available can backfire if dividends are cut or capital values fall.
A big yield and growth potential
One stock that ticks a lot of boxes is Arbuthnot Banking Group (LSE:ARBB). The small-cap bank trades on a modest forward price-to-earnings (P/E) of 8.8 and just 0.53 times book value, suggesting a significant valuation discount. By comparison, its FTSE 100 peers trade around 20% higher on a P/E ratio and 100% higher on a book-value basis.
A price-to-sales of 0.8 and strong free cash flow valuation metrics also point to a business the market may be undervaluing. Meanwhile, the forecast dividend yield of 6.59% stands out as particularly attractive for income seekers.
However, risks remain. Forecast earnings per share growth is negative as interest rate fall. What’s more, as a smaller lender, performance may also be more cyclical and sensitive to economic conditions. Nonetheless, it’s worth recognising that its clients are higher wealth individuals and likely more resilient to economic change than most of the population.
It’s certainly worth considering.
Building the portfolio
However, many people will be reading this and thinking “that’s great, but I don’t have £144k invested in an ISA“.
And that’s fine, because it doesn’t have to happen overnight. In fact, it can’t happen overnight. If someone were to put £200 into a Stocks and Shares ISA each month and achieve an annualised return of 10% — that’s marginally above the average ISA return over the past few years — they’d have £144k in 19.5 years.
That’s the long game most investors have to play. Not everyone can top up their portfolio by a grand or two each month.
Of course, it all comes down to making the right investment decisions.
