It’s possible to turn a relatively small investment into a mighty second income, but it requires one magic ingredient. Time. Oh, and patience. So that’s two magic ingredients. Plus a little commitment. Which is three.
What it doesn’t require is investment genius, a trait that’s in much shorter supply. Most ordinary people can build serious long-term wealth from investing in shares, the problem is that too few try, in my view.
It’s more than possible to generate a six-digit annual passive income by investing this year’s £20,000 Stocks and Shares ISA allowance, but it won’t happen overnight. The stock market is not a get-rich-quick scheme, so I ignore anybody who claims otherwise.
Time, patience, commitment
I believe equities are a better way of building wealth than putting money in a savings account. While rates on cash have dramatically improved, they’re likely to slide once it becomes clear inflation is defeated and central bankers start slashing interest rates. However, that will hopefully give stock markets a lift, boosting share values and making the dividend income companies pay look relatively more attractive.
While investors will have good and bad years, history shows that stocks and shares perform better than almost every other asset class, given enough time.
The simplest way to invest is to buy a low-cost fund tracking a major index like the FTSE 100. That’s how I started. But today, I prefer to buy individual stocks. By targeting companies with above average dividend yields, I can generate a far higher second income .
Right now, the FTSE 100 as a whole yields a respectable 3.9%. However, my portfolio includes wealth manager M&G, which yields 8.96%, and Legal & General Group, which yields 7.27%. If their share prices recover after a few disappointing years, I’ll get capital growth too.
The FTSE 100 has delivered an average return of 6.9% a year over the longer run, with all dividends reinvested. I hope to beat that by picking individual stocks. However, let’s say I don’t. I’d still do very nicely.
Compounding is maths plus magic
If I invested a £20k lump sum at age 30, average growth of 6.9% a year would increase it to £252,454 by the time I turned 68. If I drew 5% of my pot each year in retirement, I’d get a second income of £12,623 a year.
That’s not riches but it’s still not a bad from an initial investment of just £20k. However, investing isn’t a case of ‘once-and-done’. It takes years.
If I invested £20k a year for each of those 38 years, I’d have a staggering £3.85bn by the time I retired. Again, this assumes average growth of 6.9% a year. Drawing 5% of that annually would give me a staggering second income of £192,690.
These figures look a little fanciful, I admit it. Few of us are in a position to invest anything like £20k a year at age 30, let alone stick with it all the way to retirement. The stock market could perform worse in future, or crash just before retirement.
Yet I think the principle holds. Investing regular sums in the stock market over the long-term can reap outsized rewards. It’s not magic. More like mathematics. That’s why I’m relying on FTSE 100 shares to build a second income.
The post Here’s how I’d invest a £20k ISA to aim for £190,000 of annual second income appeared first on The Motley Fool UK.
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Harvey Jones has positions in Legal & General Group Plc and M&g Plc. The Motley Fool UK has recommended M&g Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
