Here’s how to aim for a £10k second income using an ISA

When investing for the long run, a Stocks and Shares ISA can be a powerful tool for unlocking a second income of £10,000+. And even modest investors with only £450 to spare each month can begin working towards this target right now. Here’s how.

Step 1: unlock the power of compounding

Let’s start by understanding what the goal is. By following the 4% withdrawal rule, a portfolio needs to be worth at least £250,000 to generate an annual passive income of £10,000.

This is where compounding comes to the rescue. On average, the UK stock market has generated an 8% return each year. And by drip feeding £450 each month at this rate of return, the time needed to reach £250,000 works out to be just shy of 20 years, starting from scratch.

That means even someone with no savings at the age of 40 still has more than enough time to build a solid nest egg and secure a five-figure second income before retirement.

Step 2: invest

One of the easiest ways to deploy money into the stock market is with an index fund. But for those feeling more adventurous, stock picking can open the door to potentially phenomenal results.

Take Melrose Industries (LSE:MRO) as a prime example. Over the last 20 years, the once-industrial engineering conglomerate has expanded its market-cap by 1,453%. But when dividends are thrown into the mix, the total return is actually closer to 3,188%!

That’s the equivalent of a 19.1% annualised return. And investing £450 a month at this rate not only reaches the goal of £250,000 within just 12 years, but also goes on to grow to £1.2m if the investor waits the full 20 years. And withdrawing 4% of a £1.2m portfolio translates into an annual second income of £48,000.

Still worth considering?

Today, Melrose is a very different business with a very different management team. The company has transitioned from an industrial turnaround specialist into an aerospace pureplay operating under the GKN brand. And with a £7.4bn market-cap, expecting a near-20% annualised return is likely too enthusiastic.

But that doesn’t mean Melrose doesn’t hold some interesting possibilities. Its transition into an aerospace company is rapidly approaching completion. And the results so far have been quite extraordinary, with profit margins more than doubling in the process.

Combining this with supply chain resiliency, along with a wider surge in civil and defence aerospace spending, Melrose’s revenue growth has similarly been surging. And looking out to 2029, management expects this momentum to grow its free cash flow from around £100m to £600m.  

Is this guaranteed? Of course not. Restructurings are fraught with execution risks. And the impact of poor decisions can take some time to materialise in the financials. But even if Melrose executes flawlessly, the same might not be true for some of its key customers.

If Boeing or Airbus fail to stay on schedule in terms of building new aircraft, demand for Melrose’s engine components and aircraft structures could suffer. The same is true for its defence customers, who could encounter their own supply chain challenges due to geopolitical interference.

Nonetheless, considering Melrose’s long-term potential, I feel these are risks worth taking. That’s why I’ve already added the shares to my portfolio.

The post Here’s how to aim for a £10k second income using an ISA appeared first on The Motley Fool UK.

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Zaven Boyrazian has positions in Melrose Industries Plc. The Motley Fool UK has recommended Melrose Industries Plc. 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.

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