With rising interest rates crushing the buy-to-let market, investors are looking elsewhere for a second income, and I think the stock market is a good place for that at the moment.
I think a reasonable goal is to invest £20,000 in a stocks and shares ISA that will earn £4,116 a year – or £343 a month. Here’s how it works:
The mathematics
A 5% annual return on £20,000 will result in an investment that will return £4,116 per year after 30 years. I think this is realistic given the historical returns of FTSE100but the wait is long.
However, a higher average annual return could speed up the process. For example, if you achieve a compound return of 6% per year, your portfolio will generate £3,324 per year after 23 years.
At an average annual return of 8%, the time to £343 per month is halved compared to 5%. At an interest rate of 8% per year, £20,000 becomes an investment earning £4,351 per month after 14 years.
There are no guarantees when investing. But it’s worth noting that the difference between 5% and 8% returns can be quite significant when it comes to earning £343 a month.
The strategy
With that in mind, I think it’s important to seek the best total return. And that means looking for the most attractive opportunities across the board, rather than focusing on growth or dividends.
Of course, the ultimate goal is a second income, but I don’t think that means I have to focus exclusively on stocks of companies that pay out their profits as dividends.
There are two reasons for this. Firstly, dividend stocks may not offer the best investment opportunities – and secondly, the time it takes to get to £343 a year to get a lower return could be quite high.
Another reason is that I don’t need a company that pays out money to provide a second income. As the companies I own grow and make profits, I can always sell some of my shares to realize the increase.
A stock to consider
In some ways it is more difficult when you have an unlimited universe of stocks to choose from. But one stock that I think looks attractive right now is Diageo (LSE: DGE).
Over the past decade, revenues have grown by about 4% and earnings per share by 5% annually, despite the company paying out most of its cash to investors in the form of dividends.
Growth is not without risk, however. The company has recently proven that it is not as recession-proof as some investors may have thought, as weak consumer spending has weighed on demand.
But this is a problem for companies of all kinds, and I think Diageo’s size gives it an advantage over smaller competitors that should put it in a good position in the long term.
Opportunistic investing
Whether it’s growth or passive income, investing is all about taking advantage of exceptional opportunities. That means buying shares in strong companies when prices are unusually low.
At the moment, I think Diageo meets the requirements, so I own the stock and plan to continue buying it as long as the price remains at current levels.
The post How to turn a £20,000 ISA into a second income of £343 a month appeared first on The Motley Fool UK.
Further reading
Stephen Wright holds positions in Diageo Plc. The Motley Fool UK has recommended Diageo Plc. The views expressed on companies mentioned in this article are those of the author and may therefore 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.
Motley Fool UK 2024
