Using a Stocks and Shares ISA to generate an income is a powerful investing strategy. After all, ISAs protect dividends as well as capital gains from the grubby fingers of HRMC. But getting started can be quite a daunting task, especially in 2024, given the impact of the cost-of-living crisis on many Britons.
But this shouldn’t be the case. After all, despite popular belief, it doesn’t take that much capital to get the ball rolling. And by being prudent and setting aside a portion of earnings each month, it’s possible to build up a sizeable second income over time.
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.
Getting started
A key first step on any investing journey is to get into a disciplined savings habit. By putting aside money each month from a paycheck, investors of all financial backgrounds can gradually accumulate capital to build and expand a portfolio.
Whether it’s £50 a month or £500, when left to compound, savings can grow substantially in the long run. Therefore, missing out on even a single month of contributions can be an expensive mistake, resulting in a lot of unearned wealth.
Compounding wealth in an ISA
Historically, the UK stock market’s delivered average returns of around 8% a year. And earning this rate over the next three decades can be the key to unlocking an impressive portfolio as well as sizable investment income.
Thirty years of putting aside £50 each month equates to £18,000. But when compounded at 8%, the Stocks and Shares ISA would actually be worth just shy of £75,000 – four times more!
Similarly, setting aside £500 each month results in £180,000 of savings with a portfolio reaching £745,000. And following the 4% withdrawal rule, that can be transformed into a tax-free passive income stream of around £30,000 each year.
Index investing or stock picking?
Replicating 8% returns may be harder than it seems. It’s easy to just invest in a FTSE 100 tracker. But in recent years, the UK’s flagship index has struggled to keep up with its historical pace, averaging closer to 6%. That’s still enough to meaningfully grow wealth over time. However, for investors seeking higher returns, picking individual stocks may be the more suitable approach.
This strategy obviously comes with more risk and opens the door to greater volatility. But it also allows capital to be concentrated into specific high-quality companies rather than an entire index. In fact, this concentration is how investors can beat the market.
Take Admiral (LSE:ADM) as an example. The insurance giant has more than doubled the performance of the FTSE 100 over the last five years and continues to outpace many of its peers. By being proactive with its policy pricing, the firm has managed to remain relatively competitive, resulting in double-digit customer turnover and earnings growth.
The company has a good reputation and this must help it when potential customers not just driven by price are hunting for insurance.
Of course, buying Admiral shares doesn’t guarantee positive returns moving forward. A large chunk of the recent growth stems from issuing new motor insurance policies. And this type of insurance often has far higher claim rates that may impede profitability moving forward if customers end up in fender benders.
This post was originally published on Motley Fool
