Charlie Munger famously said: “The first rule of compounding: Never interrupt it unnecessarily.” This tenet applies whether an investor has already built up a large second income or is still working towards one.
Therefore, it’s always a good idea to have some savings set aside for a rainy day. Back in the day, a rainy day would have made it difficult to work outdoors and earn income (hence the phrase).
Nowadays, it could be anything from a broken boiler to a poorly pet. The last thing an investor wants to do is sell stocks (potentially at a loss) to cover an unforeseen bill. So Cash ISAs definitely have a role to play.
But assuming this base is covered, I’d want the rest of my savings in a Stocks and Shares ISA over the long run. Here’s why.
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Stairs and elevators
Put simply, stocks deliver better long-term returns than other asset classes, particularly cash.
This doesn’t mean they’re always a sure bet, mind. Reduced dividends, bear markets and crashes, and a myriad of other events (wars, pandemics, financial panics, etc.) do happen. Often unexpectedly.
That’s why the stock market tends to deliver superior returns over time. Investors want a higher potential rate of return for taking on all this extra risk. Otherwise, why bother putting oneself through the wringer?!
Also, as a general rule, stock markets take the stairs up and the elevator down. In other words, they rise steadily but can drop dramatically.
That’s why it’s important to take a long-term, Foolish approach to investing.
Of course, tuning out all the noise when things are going south isn’t easy. But it is possible to cultivate a patient mindset with enough experience.
Life-changing passive income
Long term, the blue-chip FTSE 100 has returned almost 8% a year on average, while the mid-cap FTSE 250 has delivered around 10.5%. Both figures are with dividends reinvested rather than spent.
If this record continues, a £20k lump sum equally invested across these indexes would turn into an eye-catching £304,406 over the next 30 years (excluding any ISA platform fees).
However, if I decided to invest a further £650 a month – the equivalent of £150 a week – along the way, my total would be transformed into a mighty £1,522,806. So, just over £1.5m!
From this, I could decide to take £91,368 a year in passive income from a 6%-yielding dividend portfolio. That’s the equivalent of a tax-free £7,614 monthly second income.
A world-class company
To achieve this, I’d build a portfolio with quality stocks like AstraZeneca (LSE: AZN).
There are a number of things I like here. For starters, the pharma giant has 12 blockbuster drugs (those generating $1bn in annual sales) as well as a gigantic pipeline of future potential wonder treatments.
Naturally, some won’t come to fruition, meaning clinical trial failures are an unavoidable risk. But I find Astra’s deep pipeline reassuring.
Second, the company remains extremely ambitious. It recently said it’s aiming to grow revenue by about 75% to $80bn by 2030.
This will be through the potential launch of 20 new medicines as well as growth in its existing oncology, biopharmaceuticals, and rare disease portfolio.
Given this possibility and the firm’s excellent recent record of execution, I find the stock’s forward price-to-earnings multiple of 18.7 attractive.
