Here’s how big a second income we could target from a Stocks and Shares ISA

There’s one way in which British American Tobacco (LSE: BATS) looks ideal for working out how much we might earn from stock market investing in a second income. It currently offers a forecast 6.9% dividend yield. And that happens to be pretty much bang on the average FTSE 100 annual return of the past 20 years.

So, we can use it as a potential representative of average returns. And at the same time, we get to see how we might evalute an individual income stock.

Let’s get right to the heart of it. A single £20,000 ISA allowance invested in a stock returning 6.9% each year, with dividends reinvested, could grow to £76,000 in 20 years. And the same yield could then generate an annual second income of £5,200.

So, that’s the question answered, just put the money all in British American Tobacco and wait. Job done… Oh, hang on a minute, we really need to look a bit deeper.

More to consider

Dividends are never guaranteed. There’s no one-size-fits-all answer to long-term investment. We don’t all have the same amount of money. In fact, most of us will be investing less than £20,000 per year. But we might be able to invest regularly rather than a single lump sum.

We won’t all want to buy the same shares. I do think British American Tobacco is worth considering for those wanting to build up a passive income pot, mind.

It has a track record of dividend growth, and predictions show it continuing. Earnings haven’t risen so smoothly, but the trend is nicely up. And they should cover the dividend between 1.3 times and 1.4 times over the next three years if forecasts turn out right.

Tobacco threat

The threatened end of the tobacco insustry is a clear danger. But I’m not so sure it’ll happen any time soon. We had an update from the company on 3 June ahead of first-half results due 31 July.

The company expects “accelerating H2 New Category revenue“. That’s next-generation products that don’t involve burning and smoking the tobacco. The more that segment grows, the more I see it softening the risk. But the risk isn’t going away.

Oh, I’m overlooking possibly the worst risk of all. Do we really want to put all our eggs in one basket? That could be asking for trouble. And it’s why I say we should always target diversification in our ISA investments.

Same but different

We might achieve the same overall annual return from a diversified portfolio, although there will be ups and downs along the way. And we might, say, be able to invest £10,000 every year. We could then be talking really serious money, with the potential to build up £420,000 in 20 years. The 6.9% return on that? A cool £29,000 each year.

Here’s one last thought. Do that for 30 years with the same overall return, and we could hit £960,000. The extra 10 years could be worth more than the first 20. And we could end with £66,000 per year income.