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If we want to build up a long-term second income, our annual £20,000 ISA allowance means we could do it without paying any tax on the gains we make.
Government data shows the amount of cash put into ISAs has been declining since the 2014/15 year. But the good news is the proportion of wealth in Stocks and Shares ISAs has grown in comparison to Cash ISAs.
High interest rates make Cash ISAs look more attractive. And it can make sense to use one for shorter-term needs. Also, some savers don’t want any stock market risk and will priortise the safety of a guaranteed return.
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.
Long-term best?
For more than a century, the UK stock market had strongly outperformed cash-based savings. But what difference does a few percent either way make in reality? If we invest for the long term, it can mean quite a lot.
Consider £20,000 put into two different investments. One pays a 4.4% return every year, with the other offering 8%. Each year, we reinvest the income we receive into more of the same thing without adding any new money.
By my calculations, the £20,000 earning 4.4% per year should more than double to over £47,000 in 20 years. And the same 4.4% return could then earn an annual second income of a bit over £2,000.
But the investment paying 8% in annual returns could grow to £93,000 over the same 20 years. And 8% of that could then mean £7,400 income per year. So, an 80% better annual return could result in more than three-and-a-half times the eventual yearly second income.
Stocks beat cash
Why did I pick these two figures? They’re not just off the top of my head. No, the 4.4% is about what the best Cash ISAs I can find today are offering — likely to fall following future Bank of England cuts.
And the 8% is the current forecast dividend yield from M&G (LSE: MNG) shares — forecast to rise gradually in the next few years.
Do I suggest putting a whole ISA allowance into a single stock like M&G? No, most definitely not. I wouldn’t do that with any stock, and instead I reckon diversification across a range of businesses is essential.
Long-term diversification
We also shouldn’t depend on today’s dividend level. Stock market dividends are never guaranteed. And in tough times they can even be cut altogether.
M&G is in the savings and investment business, and can be at the mercy of stock market risk more than others. And it’s been a separate company in its own right only since being spun out from Prudential in 2019. So there’s not much of a track record yet.
But I do hope this comparison might raise a few thoughts. Investors seeking a second income should be aware that stocks and shares have beaten cash savings over the long term. And I rate M&G as one to consider as part of a diversified Stocks and Shares ISA.
The not-a-secret is to invest as much as we can each year, and keep going as long as we can.
