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For many, earning a second income is the holy grail of investing. After all, who doesn’t love the idea of making money without having to work for it?
And better yet, by leveraging an ISA, there won’t be any taxes to pay either. But how much money can an investment portfolio unlock?
The answer depends on the return a portfolio’s able to generate and how much capital an investor can put in. But even with a basic index strategy, investing just £500 each month could eventually earn £89,380 each year if the stocks in question are very successful. Here’s how.
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.
Step 1. Invest consistently
To kick off any investing journey, capital is required. The more, the merrier. But contrary to popular belief, even a relatively small sum ranging from £100 to £500 each month can be sufficient to get the ball rolling. The key is consistency.
Let’s say an investor’s putting £500 each month into their ISA. Assuming their portfolio’s yielding a return of around 10% a year in line with the stock market average, after compounding for 30 years, a portfolio would have grown to £1.1m. And following the 4% withdrawal rule that’s enough to generate a £45,200 second income.
Step 2. Buy and hold
Many investors rely on index funds to build their wealth. However, others prefer to take matters into their own hands, picking individual companies to consider investing in.
Stock picking requires a lot more effort and usually comes paired with more risk. But it also paves the way to superior returns that, in the long run, could translate into a significantly larger second income.
Take Diploma (LSE:DPLM), for example. The industrial products distribution enterprise has embedded itself heavily into the increasingly complex supply chains of its customers. As a result, Diploma commands impressive customer loyalty that’s translated into robust growth in both revenue and earnings. So much so, the stock’s delivered an average annualised return of 16.7% over the last decade for shareholders who bought and held on.
At this rate of return, investing £500 a month would even transform an empty ISA into a £2.2m portfolio or an £89,380 second income!
Step 3. Watch and review
As exciting as the prospect of earning £89k tax-free each year is, there are some important caveats to consider. First and foremost is Diploma’s past success doesn’t guarantee future returns.
In recent weeks, the US markets have entered turmoil as investors speculate about the impact of US import tariffs. The brewing trade wars are particularly problematic for Diploma, given its distributing parts and components to customers scattered all over the globe, including the US.
In fact, roughly 42% of sales currently originate from America, resulting in significant exposure that could undermine its profit margins as well as customer demand.
Of course, there are plenty of other businesses to consider beyond Diploma that could be capable of delivering a higher rate of return than the stock market’s 10% average.
However, in each case, investors need to carefully monitor and detect any looming threats to stay informed and avoid falling into traps on their journey to earn a large second income.
This story originally appeared on Motley Fool
