Buying dividend-paying stocks inside an ISA is a brilliant way to build a second income for retirement. But how much do investors need to generate a worthwhile passive income stream?
The answer is personal. It depends on whether the investor wants a luxury lifestyle in retirement or a modest but comfortable one. Let’s take the latter, targeting £750 a month from a Stocks and Shares ISA. Which works out as £9,000 a year. That’s on top of other income sources, including the State Pension.
Using the 4% rule, which suggests withdrawing 4% of your pot annually will preserve the underlying capital, an investor would need around £225,000 to generate £9,000 sustainably.
FTSE 100 stocks build wealth
Alternatively, investing in FTSE 100 shares yielding an average of 5% could produce a passive income of £11,250 a year, from the same pot. That’s around £937 a month.
So how much would an investor need to tuck away annually to reach £225,000? Let’s assume they have 30 years until retirement and their portfolio grows at an average 7% a year. If they invested £200 a month, or £2,400 a year, my assumptions would deliver roughly £242,575. That’s comfortably above target.
With only 20 years to go, they’d need to raise their game. Contributions of £435 a month (£5,220 a year) would produce £228,000, again, assuming 7% growth. The earlier investors start, the better.
Of course, actual results depend on performance. By building a balanced portfolio of individual FTSE 100 stocks, we at The Motley Fool believe investors can outpace the stock market over time.
Lloyds shares offer dividends and growth
FTSE 100 banks have done brilliantly lately. They’ve benefited from higher inflation and interest rates, which allow them to widen their net interest margins, the difference between what they pay savers and charge borrowers.
Many investors use Lloyds Banking Group (LSE: LLOY) as a portfolio building block, hoping it will deliver a steady stream of dividends and growth over the years. Lloyds took a beating during the financial crisis and took more than a dozen years to repair itself. Today though, it’s motoring. Its shares have doubled in value over the past two years, and climbed 33% in the last 12 months. That’s despite last week’s global stock market volatility.
Some might see this week’s 7.6% dip in the Lloyds share price as a buying opportunity. The stock is cheaper as a result, with a price-to-earnings ratio of 13.8. The dividend yield has edged back up to 3.77%. It’s forecast to hit 4.4% in the year ahead.
The Iran war has plunged the world into uncertainty, and the UK economy was already struggling to grow. A resurgence of inflation might protect bank margins, but also trigger a wave of bad debts if customers struggle. Any stock market crash would hit the big banks, along with many other sectors.
Still, with a long-term view, I think Lloyds is worth considering for both growth and dividend income, alongside a spread of FTSE 100 dividend stocks. As markets wobble, I can see loads of exciting growth and income opportunities right now.
