Every UK resident is eligible to open an Individual Savings Account (ISA). One type is a Stocks and Shares ISA, which allows the holder to invest up to £20k annually without paying tax on the returns.
So the question is: how could I use my ISA if I wanted to build a second income? In this article, I’ll explain exactly what I would invest in, and the two things I would be careful of with this type of strategy.
Why the S&S ISA is important
A Stocks and Shares ISA offers tax-free investing (up until the aforementioned threshold). That means I would be able to build an additional income without worrying about the taxman taking a piece.
Without it, I could potentially pay a dividend tax, capital gains tax or income tax. That would mean any second income I produce would be lower and would hinder compound interest in working its magic over the long term.
What would I invest in?
Many companies offer regular payouts – in the form of dividends – to their shareholders. These dividends are one way to share profits and make the company valuable in the long term.
For example, if I have £10,000 invested in a company that gives a 7% dividend yield, I’ll make £700 in second income that year from that stock alone.
In the last 12 months, Vodafone offered a 9.03% dividend yield, BT Group offered 6.84% and Taylor Wimpey gave 8.82% back to investors. And those are just a few of the companies that boast impressive dividends.
Of course, nothing is guaranteed and payouts do change year to year, so I would make sure to do my due diligence on any stock I invest in.
How much would I need to get started?
Any amount is enough to start producing a second income, but the more I could invest then the higher the income would be. However, more than around £1,600 a month would exceed the £20,000 Stocks and Shares ISA limit.
For example, if I could save and invest £500 per month, I would have £6,000 by the end of the year. If my holdings gave me an average dividend of 7% then that would be a £420 income in one year.
Now, let’s say I reinvested my returns while I still saved and invested £500 per month, I would have a total of £88,702 after 10 years. The 7% yield now gives a £6,209 income. Going even further, I would have a total of £606,438 over 30 years and now the same yield offers a £42,451 second income. This shows the power of compound interest over a long timeframe.
How I would manage risk
I would have to bear in mind that share price depends on the health of the company. In tough times, dividends go down and stocks lose value. Companies can even go bankrupt, which means I would lose everything I invested. I would look to minimise the risk by diversifying my portfolio into many companies.
Another risk is inflation, as rising prices would make my returns worth less. But in times of high inflation, I’d rather hold a piece of a company than keep my cash under the mattress.
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.
