Here’s how I’m trying to build my ISA to earn a £5,000 second income each month
The Stocks and Shares ISA is simply an excellent vehicle for building wealth and earning a second income. And that’s because it’s shielded from taxation. So if I double my money on a stock, there no capital gains tax. And if I want to take dividends from my holdings, there’s no income tax.
While millions of Britons use a Stocks and Shares ISA to invest, sadly a much greater proportion keep their money in savings accounts or simply have very little savings at all. And with savings accounts offering around 3% annualised growth on average, many Britons will struggle to build wealth.
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Even index-tracking investments beat savings
Index-tracking investments consistently outperform savings accounts, offering superior long-term returns. While savings accounts are safer and guaranteed, they provide minimal interest, often failing to keep pace with inflation, the MSCI World index delivered average annual returns of around 11.1% between 1978 and 2024.
This stark difference becomes evident over time. For instance, a £10,000 investment in the MSCI World index in 1979 would have grown to £960,000 in 2024. Index funds achieve this through broad market exposure, low fees, and passive management. They also provide an easy, diversified investment option that allows investors to benefit from overall market growth.
As such, and despite short-term market fluctuations, index funds have proven to be a more effective wealth-building tool than traditional savings accounts.
The maths add up
In the chart below, I’ve shown how my money (£500 of monthly contributions) would grow at 3% — representing a savings accounts — and 11.1% — reflecting the annualised growth of the MSCI World Index over the past 45 years. As we can see, the difference is relatively modest at first, but eventually the 11.1% pulls away over time. That’s simply because of compounding.
By the end of the 30 years, the index tracker’s growing by more than £100,000 a year (although that’s not guaranteed, of course). This is why it pays to start early, and also why my one-year-old has an ISA and a Self-Invested Personal Pension (SIPP)!
Moreover, with £1.1m, I could attempt to earn £60,000 annually in dividends by investing in stocks with an average yield just above 5%.
An investment to consider
Index trackers can be a great way to start investing, but something a little more exciting could be an exchange traded fund (ETF) or trust. And one of the most popular to consider in the UK is Baillie Gifford’s Scottish Mortgage Investment Trust (LSE:SMT).
It invests in growth-oriented stocks with SpaceX now representing the largest holding. It’s also the largest holding in Baillie Gifford’s Edinburgh Worldwide Investment Trust portfolio, indicating a lot of faith from the fund’s management. Scottish Mortgage’s tech-focused investments are also complemented by holdings in luxury stocks, including Ferrari.
The stock’s discounted by around 7.1% versus the estimated value of the fund’s assets. In other words, investors are buying SpaceX and Ferrari shares on the cheap. However, I know some investors will be put off by the valuations of some of the stocks held — like Tesla at 170 times forward earnings — and SpaceX, which isn’t listed and has no stock market-derived value.
Nonetheless, it’s a stock I’ll incrementally buy more of over the years. The managers have a great track record with the shares up 2,666% since inception in 1993.
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More reading
- Here’s one exciting alternative to Scottish Mortgage shares
- Don’t cry, diversify! Consider these assets to provide balance to a Stocks and Shares ISA
- Here’s how an investor could aim for an ISA that generates £10,000 each month
- 5% from a Cash ISA? Scottish Mortgage shares are already up 11% this year!
- Here’s why I think Scottish Mortgage Investment Trust shares could keep beating the FTSE 100!
James Fox has positions in Edinburgh Worldwide Investment Trust, and Scottish Mortgage Investment Trust Plc. The Motley Fool UK has recommended Tesla. 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.
