Here are 3 steps to get started
Discover some of the best strategies when choosing which stocks to buy — and how to target a long-term second income with dividends.
Posted by Royston Wild
Published 29 November
You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services.
I strongly believe the best way to source a long-term second income is with dividend-paying shares. I’ve put my money where my mouth is, too, by loading my portfolio with companies delivering stable — and in many cases, large and growing — cash rewards to their investors.
Picking the best stocks to buy comes with some work, though. Only those committed to carefully researching shares and devising a sensible investing strategy typically enjoy a robust income year after year.
Let’s get things started with three simple rules I use myself. I’m confident they could eventually turn a £20,000 lump sum investment into a regular £33,286 passive income.
1. ISA benefits
The first thing I’ve chosen to do is cut out HRMC. They’re after both my trading gains and dividends, and also have their eyes on my portfolio drawdowns.
This is why opening a Stocks and Shares ISA can be critical. These accounts prevent HMRC from charging income tax on any withdrawals you make. And by stopping capital gains tax and dividend tax, investors have more money working for them and compounding over time.
The good news is these products also have a healthy £20,000 annual allowance. This is more than enough for almost all Britons (only 7% of people max out their ISAs each year).
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.
2. Growth, value, dividends
When building one’s portfolio, it’s important to aim for a balanced range of growth, value, and dividend-paying stocks.
Growth shares can deliver strong capital gains over time as profits rise and share prices increase. Value shares can also enjoy stunning price appreciation, albeit in a different way. They can re-rate over time as investors realise their cheapness, benefitting early buyers.
Dividend stocks, meanwhile, can provide a steady flow of income that can be reinvested to boost compound returns. What’s more, dividend shares — unlike growth and value stocks — can help a portfolio deliver a positive return even during stock market downturns.
3. Diversify for strength
Equally critical is to build a portfolio that spans spanning different regions and sectors. Investment trusts like F&C Investment Trust (LSE:FCIT) can be simple yet highly effective ways to achieve this.
This FTSE 100 trust has delivered 54 straight years of dividend increases, illustrating the stability it offers. But that’s not all. Its share price has risen at an average annual rate of 6% over the past decade.
F&C manages roughly £6.6bn worth of assets, including more than 350 global equities. Holdings are as varied as Nvidia and Amazon, right through to HSBC, Siemens, and Pfizer.
Like any stocks-focused trust, performance can suffer during broader stock market downturns. But as we’ve seen, its commitment to share investing also helps it tap into the lucrative long-term returns equities can bring.
Targeting a £33k income
With a diversified portfolio including trusts like this, I believe it’s quite possible to make an average yearly return of 8%. At this rate, someone investing £500 a month could come out with a healthy £475,513 after 25 years.
This could then be invested in 7%-yielding shares to target an annual second income of £33,286.
One small problem being, even allowing for inflation, would be to buy 20 different shares, Investment Trusts/ETFs paying a ‘secure’ 7%, if interest rates were very low, of course they could be higher.
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