Image source: Getty Images
Investing in income stocks that pay regular dividends remains one of the most popular ways to earn a second income from the stock market. With high-priced tech and growth stocks experiencing skyrocketing valuations, dividend stocks could be worth considering in 2026.
For example, consider how this method of using the £20,000 annual ISA limit could target a regular income of £15,000 a year.
Optimising gains
By investing via a Stocks and Shares ISA, UK residents can reduce their tax outgoings significantly. Current ISA rules allow up to £20,000 invested per year with no tax levied on the capital gains. Plus, the upcoming Autumn Budget threatens to reduce this limit for Cash ISAs, making stocks and shares even more attractive.
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.
Even if you don’t have the full £20,000 to invest in one go, regular contributions combined with reinvested dividends can be a powerful compounding force.
Many ISA investors achieve almost 10% returns on average a year. At that rate, a monthly contribution of just £300 could hit £20,000 within four-and-a-half years. But that’s not guaranteed and investors could achieve a lot less, of course.
Building an income stream
Let’s say growth continued at an average rate of 10% per year. That £20k could reach £241,200 in 25 years. To avoid eroding the pot, retirement experts recommend withdrawing only 4% a year. That would bring in £9,600 a year.
At the same time, were it a high-yielding portfolio paying out 6% on average, it could deliver £14,500 in dividends annually.
Any withdrawals would naturally reduce the dividend payments over time. But this example shows how a retiree could combine dividends with minor withdrawals to achieve a steady income for many years.
Beating the average
But to achieve an average return of 10%, an investor would need to do more than simply invest in a passive index tracker. For example, the FTSE 100 has historically returned less than 7% on average.
A common tactic that income-focused investors adopt is identifying stocks with higher-than-average yields to help boost returns within a diversified portfolio.
When thinking of dividends, long-term sustainability is critical. One stock that exemplifies this concept is Schroders (LSE: SDR), with an attractive dividend yield of 5.5% and 25 years of continuous dividend payments with no reductions.
It currently pays 21.5p per share annually, with dividends growing at a compound annual growth rate of 9.37%. That alone is no guarantee it’ll continue, so it pays to assess the company’s financials. Its worth noting that income dropped 29% year-on-year in its latest half-year results.
But overall, revenue and earnings have been fairly stable for years, which is what we’re looking for.
One risk is that dividend coverage is a bit thin, with a high payout ratio above 90% and cash coverage of only two times. A big profits hit could risk a dividend cut even with such an exceptional track record.
The bottom line
Building towards a second income stream takes time and dedication. But new investors are often surprised at how quickly growth compounds when they reinvest the dividends.
Schroders is just one example of a stock worth considering as part of a diversified portfolio of dividend shares. The Motley Fool regularly updates its findings with similar income stocks offering long-term sustainability.
