With rising interest rates crushing the buy-to-let market, investors are looking elsewhere for a second income. And I think the stock market is a good place to look at the moment.
By investing using a Stocks and Shares ISA, I think £20,000 into an investment that can pay £4,116 per year – or £343 per month — is a sensible ambition. Here’s how.
The maths
A 5% compound annual return on £20,000 results in an investment that earns £4,116 per year after 30 years. I think that’s realistic, given the historic returns of the FTSE 100, but it’s a long time to wait.
Earning a higher average annual return could speed the process up, though. For example, earning a compounded return of 6% per year results in a portfolio generating £3,324 per year after 23 years.
With an 8% average annual return, the time to £343 per month halves compared to 5%. Compounded at 8% per year, £20,000 turns into an investment yielding £4,351 per month after 14 years.
Nothing is guaranteed when it comes to investing. But it’s worth noting that the difference between earning 5% and earning 8% can be quite significant when it comes to getting to £343 per month.
The strategy
Given this, I think it’s important to aim for the best overall return. And this involves looking for the most attractive opportunities across the board, rather than concentrating on growth or dividends.
Obviously, the eventual ambition is a second income. But I don’t think that means I need to focus exclusively on shares in companies that distribute their earnings as dividends.
There are two reasons for this. One is the best opportunities might not be in dividend stocks – and the cost of settling for a lower return in terms of time to get to £343 per year could be quite high.
Another is that I don’t need a business to distribute cash to earn a second income. If the companies I own shares in grow and retain earnings, I can always sell part of my stake to realise the increase.
A stock to consider
In some ways, having an unlimited universe of stocks to choose from makes it harder. But one that I think looks attractive at the moment is Diageo (LSE:DGE).
Over the last decade, revenues have grown at around 4% per year and earnings per share at 5%. And this has happened while the company has returned most of its free cash to investors as dividends.
The growth isn’t risk-free, though. The company has recently proved that it isn’t as recession-resistant as some investors might have imagined as weak consumer spending has been weighing on demand.
This has been an issue for companies across the board, though. And I think Diageo’s scale gives it an advantage over smaller rivals that should put it in a good position for the long term.
Opportunistic investing
Whether it’s growth or passive income, investing well comes down to seizing exceptional opportunities. That means buying shares in strong businesses when prices are unusually cheap.
Right now, I think Diageo fits the bill. That’s why I own the stock and why I plan to carry on buying it while the price stays near its current levels.
