For me, the very best way to earn a second income is by putting money in an ISA and following a well-trodden investment strategy in order build wealth. Of course, the more money an investor has, the easier it is to generate a large passive income.
Sadly, most Britons still elect to build wealth through savings accounts, which with annualised returns typically below 3%, that money isnât growing very quickly.
Stock markets typically perform better than savings
Investing in stock markets typically yields significantly higher returns compared to traditional savings accounts. Many individuals, particularly beginners, opt for index-tracking funds, which aim to replicate the performance of major market indexes. Historical data underscores the long-term growth potential of such investments.
For instance, the FTSE 100 has delivered an average annual return of 6.3% over the past 20 years, with the FTSE 250 outperforming its large-cap counterpart. In the US, the S&P 500‘s averaged an impressive 10.5% annually since its inception in 1957, climbing to an even higher average of 13.3% in the decade leading up to 2024. Similarly, the Nasdaq posted an exceptional 19.8% average return over the past decade.
These figures starkly contrast with the comparatively modest interest rates offered by savings accounts, emphasising the advantage of stock market investments for building wealth over the long term.
Doing the maths
Personally, I prefer to pick individual stocks, trusts and specific funds, over index-tracking funds. Thatâs because I believe I can beat the market â after all, researching stocks is essentially what I do.
However, if an investor had chosen a tracker of any of the above major indexes over the last decade, they would have vastly surpassed the returns they could have achieved in a savings account. Letâs assume an investor puts £500 a month into an index tracker. Hereâs how that money could perform in an S&P 500 tracker, based on the previously noted historical growth rates (but note, past performance is no guarantee of future success).
Thecalculatorsite.com
Why did I use the S&P 500 data? Well, because it quite conveniently works out to just over £1.2m over 30 years. Putting that money in stocks with an average dividend yield of 5% would generate £5,000 of monthly passive income â and tax-free. This is what Iâm aiming to do, but by cherry-picking stocks, Iâm hoping to grow my money faster.
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.
One to consider for the growth phase
While index trackers are a great way to start investing, investors may want to consider an exciting growth-oriented trust like Edinburgh Worldwide Investment Trust (LSE:EWI). Itâs a Baillie Gifford-run fund â like the well-known Scottish Mortgage Investment Trust â and itâs a really interesting, albeit risky proposition. The fund aims to invest initially in entrepreneurial companies when theyâre still nascent.
The trust’s largest investment is SpaceX, which represents a significant 12.3% of the portfolio. This is followed by PsiQuantum at 7.5% and Alnylam Pharmaceuticals. These are fairly high-risk investments, but given supportive trends in artificial intelligence (AI), space exploration, and even quantum computing, this could be the right time to take a diversified approach to emerging technologies.
However, some of its holdings arenât publicly listed, and only listed companies are required to disclose earnings reports, which means crucial data on these private entities is scarce, heightening uncertainty for investors.
The post Hereâs how Iâm trying to build up my ISA to earn £5,000 in passive income each month appeared first on The Motley Fool UK.
Pound coins for sale — 31 pence?
This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!
Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.
What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?
See the full investment case
More reading
Hereâs how much an investor would need in an ISA to earn £3,000 of passive income monthly
The only FTSE 100 shares I own at the start of 2025
Can Scottish Mortgage shares lead the next bull market charge?
3 great investment trusts to consider for a Stocks and Shares ISA in 2025
5 investment trusts to consider for a new 2025 ISA
James Fox has positions in Edinburgh Worldwide Investment Trust and Scottish Mortgage Investment Trust Plc. The Motley Fool UK has no position in any of the shares mentioned. 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.
