Here’s how I’d use my ISA to build a lifelong second income

More money but no extra work? That may sound too good to be true. But there is more than one way to earn extra income. For example, one method I use is to build a portfolio of stocks that will hopefully pay dividends in the future.

Here’s how I could do it, using an ISA with £20,000 (although the same approach could work with less money – I’d just get less).

Prepare to invest

To start, I will set up a Stocks and Shares ISA and put the cash in before the annual contribution deadline early next month. That way, I’ll be ready to invest when I decide what stocks to buy when I’m trying to generate more income.

But just because I’ve put money into my ISA doesn’t mean I’m in a rush to invest. Once I’ve decided what stock to buy, I can buy it right away. But if I still choose, or the price of the stock I like has not caught my attention, I will wait patiently before making money.

Buy dividend stocks

What kind of stocks should I be looking for?

My second income will be generated from dividends. So, I want to invest in a business that I feel can generate profits for many years or decades, that can be paid out as dividends.

First, I’ll look for areas that I think customers will want in the long term. I then sought to identify companies operating in areas that I felt had some competitive advantage.

For example, the parents of Google Alphabet has what I see as a strong competitive advantage in an area I expect to see strong demand for a long time. The stock is also trading at what I see as an attractive valuation.

But there is a final criterion that will be used: will the company pay out profits as dividends?

Alphabet does not, for example, keep profits inside the business to fund growth. In contrast, I get good dividends from stocks owned in mature industries. British American Tobacco precedent.

Build a second income

How much I can get from this approach depends on several factors.

One of them is the average yield of the stocks I bought. If I put £20,000 into shares with an average return of 10%, my annual second income should be £2,000. If it yields 5%, I should be earning £1,000 a year in dividend income.

The company could stop paying dividends (or worse, go bankrupt) so I spread my ISA investments across different stocks. I hope this means that investing £20,000 today will allow me to double my income in decades.

If I choose the right company with a great business, it can grow profits and dividends over time. That way, I can see an increase in my annual dividend income.