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How I’d invest £3 a day in an ISA to get a second income of £37,957 for life

Mature couple in a discussion while eating a meal in a restaurant.

The Stocks and Shares ISA is a brilliant way to generate a second income for my retirement because it’ll all be free of tax. Better still, by investing my £20,000 allowance in FTSE 100 dividend stocks, I can tap into today’s super-high yields.

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.

It’s possible to generate a high long-term income by investing relatively small initial sums. While £3 a day doesn’t sound much, if increased year by year it will steadily roll up.

Too many people see investing in stocks and shares as a get-rich-quick strategy, but in practice it’s the opposite. At the Fool, we believe that the real benefits come over time, as share price growth and dividend income compound year after year.

I’m getting rich slowly

Let’s say I invested £3 a day from age 30. If I increased that by 5% a year, to keep pace with inflation, and generated the long-term average FTSE 100 return of 6.89% a year, by retirement at 67 I’d have £352,110.

Personally, I prefer to buy individual FTSE 100 stocks, as this gives me a shot at beating the index. If I generated a return of 9% a year by doing this, I’d have £542,243 at 67. There are no guarantees, of course. If my stock picks underperform, I could end up with a lot less.

If I didn’t start saving until I was 40, I’d have to up my initial investment to £8.25 a day to achieve the same sum over the shorter 27-year timescale.

Beating the market is never easy but the stock market’s recent poor run offers a double advantage to today’s investors. First, loads of top UK blue-chips are now trading at cheap valuations. Second, dividend yields have risen dramatically as a result. 

To take just one example, FTSE 100 mining stocks have been hit by fears of a slowdown in China, the world’s biggest commodity consumer. The Rio Tinto share price has crashed 25% in just six months (it’s down 6.99% over one year).

Rio’s shares are now cheap as a result, trading at just 7.15 times earnings (a figure of 15 is usually seen as fair value) while the yield has rocketed to 8.83%. Dividends are never guaranteed, but now looks like a good time to secure high long-term income at a low price. There are loads more FTSE 100 shares in a similar position. While the index could fall even further, history shows that it will recover, given time.

While I’m working I will reinvest all my dividends back into my portfolio to pick up more stock. I’ll only draw them as a passive income stream once I retire.

Well worth the effort

Now let’s go back to my £352,110. If the shares in my portfolio yielded on average 7%, that would give me tax-free ISA income of £24,648 a year, allowing me to leave my capital untouched. If I had £542,243, my ISA income would be £37,957.

That will obviously be worth less than today due to inflation. However, my second income does come on top of the state pension and other workplace or private pensions. It’s the start of a pretty decent retirement. Which isn’t bad from £3 a day. Now imagine if I’d started with £5.

The post How I’d invest £3 a day in an ISA to get a second income of £37,957 for life appeared first on The Motley Fool UK.

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More reading

  • Near a 52-week low, is Rio Tinto the FTSE 100’s best value stock?
  • 7% dividend yields! 2 FTSE 100 shares I’m considering buying following the recent mini-crash
  • 6.6% and 6.4% yields! Which of these FTSE 100 dividend stocks should I buy today?
  • Down 22%, is it time to buy this LSE stock for high passive income?
  • Rio Tinto shares are down 19% in 6 months. Is this a great buying opportunity?

Harvey Jones has positions in Rio Tinto Group. The Motley Fool UK has no position in any of the shares mentioned. 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.