Earning a second income from dividend stocks is a popular way to fund a successful retirement. With a £50,000 lump sum, I’d put that money to work straight away so my dividend portfolio could grow over time thanks to the power of compound returns.
Here’s how I’d target £30,000 in annual dividend income from this starting point.
Lump-sum investing
It’s daunting to invest savings into stocks all at once. After all, share prices are notoriously volatile. Lump-sum investing means I’d run the risk of buying shares before a prolonged downturn, or worse still, a stock market crash.
However, Vanguard research shows that lump-sum investing outperforms cost averaging (making a series of smaller investments) 68% of the time historically, using the MSCI World Index as the benchmark.
To manage my risk, I’d set aside an emergency fund in a non-volatile asset class like cash. In doing so, I hope to avoid selling my stocks when share prices are down.
Imagine my monthly expenses totalled £2,500. I’d put three months of expenditure in an easy-access savings account and invest the remaining £42,500.
Tax optimisation
Next, I need to choose an investment vehicle. To minimise my tax bill, I’d invest £20,000 in a Stocks and Shares ISA. I’d keep the remainder in a general investment account until the next tax year. Inside an ISA, all capital gains and dividends are awarded tax-free treatment.
I’m entitled to a £6,000 capital gains tax allowance and a £1,000 tax-free dividend allowance on my investments outside the ISA wrapper this tax year. So, unless my stock market gains exceeded expectations — which is a nice problem to have! — I doubt I’d have to pay tax on my returns.
That’s because I can move an additional £20,000 into my ISA in 2024/25 (provided the rules don’t change). Then I can put whatever’s left in my general investment account into my ISA in 2025/26.
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.
Earning a second income
So, how would I target a £30k second income from dividend stocks?
I’d invest my £42.5k lump-sum into both passive funds and individual shares. For example, I could invest in the Vanguard FTSE 100 UCITS ETF. This fund mirrors the FTSE 100 index’s performance and currently yields 4.28%.
In addition, I’d buy high-yield dividend shares to boost my portfolio’s yield. Some companies offering bumper yields, which I currently own, include:
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British American Tobacco — 8.95% yield
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Rio Tinto — 7.68% yield
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Taylor Wimpey — 8.55% yield
If my portfolio’s average yield was 5%, I’d need to have £600k invested. So, if my holdings grew at a compound annual growth rate of 8% (combining share price appreciation and dividend reinvestments), I’d hit my target in under 34.5 years!
With £42.5k at 30, in theory I wouldn’t need to invest another penny to secure £30k in annual passive income by the time I’m 65.
Of course, this rate of return isn’t guaranteed. Neither are the dividends I’d rely on in retirement. If my stocks underperformed or the companies I invested in cut their payouts, I’d have to make additional contributions to achieve my goal.
Nonetheless, earning a £30k second income starting with £50k is achievable with a long-term investing horizon and a disciplined approach. It’s time to put my plan into action!
The post £50k in savings? Here’s how I’d aim to turn that into a second income of £30k a year! appeared first on The Motley Fool UK.
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Charlie Carman has positions in British American Tobacco P.l.c, Rio Tinto Plc, and Taylor Wimpey Plc. The Motley Fool UK has recommended British American Tobacco P.l.c. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2023