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Investing in the stock market can be a great way of earning a second income. But investors need to think carefully about the best available opportunities.
Dividend stocks can be a terrific choice. But they aren’t the only way to generate income from an investment portfolio and they might not even be the best.
There’s more than one way to get cash out of a portfolio. And doing it by selling part of a stake in a company can be advantageous from a tax perspective.
Taxes
A Stocks and Shares and ISA is a great asset for investors. But it isn’t an option for everyone and for those that have to invest without one, it’s important to think about tax implications.
In the main, there are two ways investors can find themselves having to give their returns to the government. The first is dividend tax and the second is via taxes on capital gains.
One big difference between the two is the tax-free thresholds. This is much higher in the case of capital gains (£3,000) than dividends (£500), which can be significant for investors.
Basic rate taxpayers looking to generate £2,000 from a £10,000 investment have a choice. They can either look for companies that will pay dividends or focus on capital gains (or both).
There are two disadvantages to the dividend approach – our £2,000 target is above the tax threshold and it’s hard to find that kind of yield. But neither of these applies to the capital gains strategy.
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.
Capital gains
A £2,000 return on a £10,000 investment translates into a 20% return, which is huge. But there is one stock where I think it might be a genuine possibility.
3i (LSE:III) is a FTSE 100 private equity firm. And the increase in the company’s book value – the difference between its assets and its liabilities – has grown at almost 20% per year.
In other words, someone who owned 1% of the business in 2015 has been able to sell 20% of their stake each year and still have an investment with the same value. That’s important.
A £10,000 investment is enough to generate £2,000 per year. Fluctuating share prices mean this can’t be guaranteed, but I think the business has shown it has a sustainable competitive advantage.
Growth
The key to 3i’s impressive growth has been the success of its investments. And it has a unique approach that sets it apart from other private equity firms on this front.
It’s easy for private equity firms to get stuck buying at the wrong times. Investors are typically more forthcoming when things are going well, but this usually means prices are high.
Unlike its rivals, 3i focuses on investing its own money, rather than taking in capital from clients. This allows it to be more selective about looking for opportunities at the right time.
The risk with this is it can result in a highly concentrated portfolio, which has happened with 3i. So investors considering the stock should think about it as part of a portfolio with other assets.
