Owning a portfolio of income stocks is a great way of earning extra cash. And with certain tax advantages, a Stocks and Shares ISA is the ideal investment vehicle to hold them. But how could a novice investor start on this journey?
Here’s a five-step guide.
1. Open an ISA
First, it’s necessary to choose an ISA provider. Inevitably, there will be a bit of paperwork involved but once that’s out of the way, it should be a relatively straightforward process to deposit some cash.
2. Maximise the opportunity
Each tax year, an investor’s allowed to put £20,000 into an ISA. All capital gains and income can be earned tax-free. This means the value of the investment pot’s likely to grow faster than with some other alternatives.
Please note that tax 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.
3. Start building a portfolio
The next step is probably the most difficult. It requires identifying some stocks to buy. How many? Well, it depends on an individual’s risk appetite. Putting all an investor’s eggs in a single basket isn’t a good idea. Instead, it’s better to buy a few shares. This helps mitigate against one (or more) of your stocks performing badly. Inevitably, some will do better than others.
The UK’s largest listed companies can be found on the FTSE 100. Generally speaking, these have the strongest balance sheets. In theory, this means their earnings tend to be the most reliable.
Since the pandemic, Tesco (LSE:TSCO) has been one of those that’s consistently delivered a strong performance. Despite facing intense competition, particularly from the German-owned discounters, it’s managed to increase its market share.
| Period (52 weeks ended) | Adjusted operating profit (£m) | GB grocery market share (%) |
|---|---|---|
| 26.2.22 | 2,825 | 27.3 |
| 25.2.23 | 2,509 | 27.3 |
| 24.2.24 | 2,829 | 27.7 |
| 22.2.25 | 3,128 | 28.3 |
Each year during this period, it’s paid a dividend to shareholders. This is a distribution of profit and is intended to compensate for the risk of owning the grocer’s shares. After all, they could go down in value.
If Tesco started to see its position as the country’s leading food retailer threatened or if, for example, supply-chain inflation eroded its profit margin, then its share price might fall. And it might cut its dividend.
However, the business has proven to be remarkably resilient in recent years. It’s successfully adapted to changing shopping trends, including more people buying online. In my opinion, it’s a stock to consider.
4. Be patient
Since April 2021, its share price has risen by an average of 14.3% a year. At this rate, a £20,000 investment would grow to £565,179 over 25 years.
Over the same period, its average dividend yield (the annual payout divided by its share price) has been 3.69%. Apply this to our ISA and it would be possible to generate an annual second income of £20,855.
5. Buy more
However, by reinvesting dividends, it’s possible to achieve an even better return.
Using Tesco as an example, the five-year average return would increase from 14.3% to 18.5%. A £20,000 investment would be worth £1.39m after 25 years. This would produce an annual income of £51,406 assuming a yield of 3.69%.
These figures illustrate why so many see the stock market as a great way of building long-term wealth. And by holding a diversified portfolio containing some great British companies, like Tesco, I think it’s possible to earn a healthy second income.
