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Like many who squirrel away money in a Stocks and Shares ISA, my long-term goal is a second income. The cash I’m putting away is slowly snowballing through a portfolio of what I believe to be excellent companies. One day I will shift towards withdrawing from the account (all tax-free of course).
If I can target something like £2,000 a month, then it opens up a window of opportunity. That might be the funds I need for early retirement. It could be a decent chunk of change for a rainy day. On a pessimistic note, I think there’s a fair chance I might need it because the State Pension might not very generous when I get to that age too.
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Sizing
How big will my ISA need to be for that goal? Well, it comes down to the withdrawal rate. In other words, the percentage I can withdraw or receive as dividends on an indefinite basis and without, hopefully, eating into the overall balance.
There’s a danger to this. That’s because many new investors look at historical returns for stock markets and bank on them for the future. For reference, the London Stock Exchange has returned around 9% a year (on average) going back over a century. For US stocks, the figure is a little higher at just above 10%.
Does that mean I can withdraw 10% of the balance a year? Absolutely not! We need to account for down years when withdrawing a big slice means selling a large chunk of the portfolio at a low point.
Also inflation accounts for a few percent of that increase too. Even during the withdrawal phase, we need our balance to keep growing to keep pace with inflation.
A common rule of thumb is to target 4% of withdrawals. At that level, a £2,000 monthly second income (or £24,000 yearly) would need an ISA with £600,000 in it.
Decisions
Over half a million is a fair chunk of change, which is why we want to invest in world-class companies that can grow the money we put in. Rolls-Royce (LSE RR.) has been one of those of late, up 11 times in the last five years. Just one or two of such great firms can boost the return rate above the average.
I think Rolls-Royce has a bright future too. Just this week, the location of the first SMR (small modular reactor) has been chosen, Wylfa, on the island of Anglesey in Wales. These baby nuclear power stations could deliver oodles of green energy with a fraction of the issues that plague building bigger nuclear power plants like Hinckley Point C.
SMRs are still an unproven technology however. There’s no guarantee this will be a strong source of future sales for the company. Dealing with the inherently unpredictable nature of what’s on the horizon is a difficulty with investing in any stock and building a high-quality ISA in general.
Overall though, the introduction of new technology has made for some very good stocks over the years. I’m hoping it will do the same for Rolls-Royce. I’d say it’s one to consider for an ISA built towards a second income.
