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A second income sounds like a luxury few can afford, but building one from scratch is more achievable than many people think. At 30, an investors has plenty of time to do it, but older people can manage it too.
The goal here is passive income, cash that rolls in without having to clock in, and it’s possible to generate it completely tax-free inside a Stocks and Shares ISA. Thanks to the £20,000 annual ISA allowance, investors can take their income free of both dividend tax and income tax for life, with capital gains shielded as well.
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.
I keep a pot of cash in a high interest instant access account for emergencies, but my long-term wealth is all in shares, mostly gleaned from the FTSE 100.
Compound growth builds and builds
Historically, the FTSE 100 has delivered average annual returns of around 8% a year. That doesn’t mean it climbs every year, but the ups more than outweigh the downs.
According to the 4% rule, a £300,000 pot could produce £12,000 of annual income for life without running dry. That’s because stock market growth makes good the withdrawals.
Targeting a £300k portfolio is no small feat, but the sooner the journey begins, the more time compound growth has to work. For example, a 30-year-old who invests £500 a month into an ISA growing at 8% a year could potentially have £296,538 by age 50. Stick with it to age 65 and they’d have a bumper £1,116,613.
Obviously this takes discipline. Both when paying money in, and resisting the temptation (or necessity?) to make withdrawals. It’s not easy-peasy.
Engineering steady returns
One stock I’ve been watching closely is Diploma (LSE: DPLM), a specialist industrial distributor that joined the FTSE 100 in September 2023. It helps connect customers with obscure, specialist components, and its niche expertise makes it difficult for new rivals to compete.
Its two-pronged growth strategy involves both acquiring new firms and expanding its existing operations. Over the past year, the share price is up 25%, and over five years it’s surged 192%. That’s impressive, although no stock rises forever. Tariffs are a concern for an international business like this one. As is the wider global slowdown.
Today’s trailing dividend yield of 1.15% looks low but that’s mostly down to the soaring share price, as Diploma has a stellar track record of hiking shareholder payouts for more than 25 years.
The shares currently trade at a price-to-earnings ratio of over 50, which is high. Investors seem willing to pay a premium for what they see as reliability and growth, but personally, I wouldn’t consider buying at this price.
I rate Diploma highly though and will keep it on my watchlist while I look for more attractively-priced alternatives.
Spreading risk over time
I’d aim for a portfolio of around 15-20 stocks from different industries. Not every share will smash expectations, but a balanced mix of income and growth plays can balance risks.
This approach has worked for me. Over time, patience, discipline, and regular investing should help generate a second income that lasts.
