Here’s how that spare cash could become a life-changing second income
Spare cash might be in short supply at the moment — a few hundred pounds left over at the end of the month, perhaps. But used wisely, that surplus can be the foundation of a second income stream.
It just takes consistency. I mean the consistency to invest that few hundred pounds at the end of the every month, and the consistency to reinvest any profits received through share sales or dividends.
Compounding helps, a lot
Compounding is the process where investment returns generate further returns over time. It’s often described as “interest on interest”, but it applies just as powerfully to dividends and capital gains. The earlier and more consistently one invests, the greater the impact.
Take a simple example. Someone who invests £250 a month in a portfolio that grows at an average annual rate of 7% — a modest rate in line with long-term stock market averages.
After 10 years, they would have contributed £30,000. But thanks to compounding, the portfolio would be worth around £43,000. After 20 years, the total contributions would be £60,000, yet the portfolio could be worth over £125,000. And after 30 years? The same monthly habit could build a pot worth more than £295,000.
From there, a second income can emerge. Drawing just 4% annually from that £295,000 could provide almost £1,000 a month. And because the capital stays largely intact, it can keep working to generate income well into the future.
The ISA route
What’s more, by investing through a Stocks and Shares ISA, all income and gains can be shielded from tax. That makes each pound invested go further. Naturally, markets fluctuate, and returns aren’t guaranteed year to year. But with time, diversification, and regular investing, the odds tilt significantly in favour of the disciplined investor.
It’s also worth noting that some investors can do a lot better than 7% annualised returns. My portfolio almost doubled in value last year. While that’s unsustainable, it does mean my long-term average is likely to be a lot higher than 7%. That said, some investors might also do worse as no returns are guaranteed.
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.
Stocks for the job
For those less inclined to research and monitor individual shares, putting spare cash into a diversified investment trust or fund can be an effective starting point. The Monks Investment Trust (LSE:MNKS), for example, aims to deliver long-term capital growth by investing in a global mix of high-quality companies.
Managed by Baillie Gifford, it focuses on identifying businesses with the potential for sustained earnings growth over many years. Thus, it offers exposure to innovative firms across developed and emerging markets.
Current holdings include a blend of well-known global names like Microsoft, Alphabet, and Amazon, alongside lesser-known but fast-growing businesses in healthcare, technology, and industrials. The trust is diversified across sectors and geographies, helping to reduce the impact of any one company or region underperforming.
One feature to be aware of is gearing. This is the use of borrowed money to increase investment exposure. While this can amplify gains during market upswings, it also magnifies losses in downturns. That said, Monks uses gearing in a measured way and has a long history of navigating volatile conditions. It’s a stock I keep adding to my daughter’s SIPP, and maybe I’ll add it to mine.
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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. James Fox has positions in Alphabet and The Monks Investment Trust. The Motley Fool UK has recommended Alphabet, Amazon, and Microsoft. 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.
