With £5,000 in a Stocks and Shares ISA, an investor has more than enough to start building a tax-free second income. And by exclusively and consistently targeting high-quality dividend stocks, this income stream can compound into an impressive £1,044.22 over the course of 15 years.
Here’s how.
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.
What’s the plan?
The fastest and easiest way to deploy capital in the stock market is with a FTSE 100 index tracker fund.
This instantly diversifies the £5,000 across the UK’s 100 largest businesses, giving indirect exposure to a vast array of industries as well as dividend-paying stocks. And right now, the yield on the UK’s flagship index is 2.96%.
That means a £5,000 investment today will instantly generate a £148 second income overnight. However, that payout could grow over time.
On average, FTSE 100 companies have increased their dividends by close to 3.2% a year over the long term. And at this rate, after 15 years, this initial 2.96% yield could grow to 4.75%, boosting the income stream to £237.50.
That’s a 60.5% increase. And this growth would be amplified even further if an investor decides to reinvest dividends paid along the way instead of just taking the income from day one.
Aiming for £1,044.22
Instead of relying on passive index funds, investors can buy shares of high-quality dividend-paying stock directly, opening the door to potentially vastly superior results.
A perfect example of this in action is Safestore Holdings (LSE:SAFE).
The UK’s leading self-storage operator has built up an impressive empire over the last 15 years. And with largely fixed operating costs, the company has transformed itself into a free cash flow generating machine that’s funded an ever-increasing dividend.
Yet unlike the overall FTSE 100, the payout growth stands at an average of 12.4% per year. Subsequently, anyone who bought shares in April 2011 has gone from earning a roughly 3.6% yield to a whopping 20.9% payout today.
In other words, a £5,000 initial investment 15 years ago is now generating a £1,044.22 second income. And once again, that’s just the tip of the iceberg compared to investors who were reinvesting payouts along the way.
Is Safestore still a buy?
Since inflation and higher interest rates came knocking in 2022, Safestore shares haven’t been a terrific investment. The dividends kept flowing, but growth and earnings suffered as demand for self-storage from both businesses and consumers slowed.
But earlier this year, management announced the company had reached a critical “inflection point”.
Demand across the UK and Europe is starting to tick back up. And with the company continually investing throughout the downcycle, Safestore is now in a seemingly strong position to not only capitalise on an industry-wide recovery, but steal market share simultaneously.
In other words, the dividend growth story doesn’t appear to be over.
Having said that, success is not guaranteed. We’ve already seen the headwinds higher interest rates create for this business, and with energy costs rising rapidly, Central Banks may be forced to reverse some of their recent cuts.
What’s more, with the UK self-storage market already fairly mature, strong growth will likely be dependent on the group’s younger European operations – a market where self-storage penetration remains relatively shallow.
Nevertheless, with a superb track record, these are risks worth taking. That’s why I’ve already added Safestore shares to my income portfolio.
