How I’d invest £300 a month in UK shares to target a £30,855 annual second income

Owning UK shares can build substantial wealth for patient investors. Given sufficient time, high-quality mid-cap and even small-cap stocks can deliver big returns that can unlock an impressive income stream. Even for an investor that can only spare £300 a month, that’s enough to potentially establish a second annual income of £30,855.

Investing for long-term growth

The most popular stock market index in the United Kingdom is the FTSE 100. However, the FTSE 250 may be more suitable for growth-seeking investors. Why? Because the index contains almost exclusively medium- and small-sized enterprises with significantly greater growth potential than the stalwarts inside the UK’s flagship index.

In fact, since its inception in 1992, the UK shares inside the FTSE 250 have delivered an average annualised total return of 10.6%. And that’s even after dropping by nearly 20% in 2022. By comparison, the total annual returns of the FTSE 100 over the same period are closer to 7.1%.

Let’s assume these indices continue to deliver these average returns for the next 30 years. What would a £300 monthly investment transform into?

FTSE 100 FTSE 250
5 Years £21,533.55 £23,603.20
10 Years £52,212.18 £63,610.24
20 Years £158,189.35 £246,360.45
30 Years £373,295.47 £771,395.97

Needless to say, the 3.5% difference in returns, compounded over three decades, has an enormous impact. And by following the 4% withdrawal rule, a portfolio worth £771,396 would provide an annual income of £30,885.84.

UK shares can be volatile

As exciting as the prospect of earning £31k for doing nothing is, there are some risk factors to take into consideration. The higher returns of the FTSE 250 aren’t without their risks. As I said previously, the index can be volatile.

With economic instability rising courtesy of expanding inflation, many UK shares were pummelled into the ground last year. And the majority were mid- and small-cap stocks. Why? Because these smaller companies typically have fewer resources at hand to weather bad operating environments. On the other hand, large-cap stocks can leverage their size to withstand such storms and are usually more resilient.

Nothing paints this picture more clearly than comparing the performance of the FTSE 250 versus the FTSE 100 in 2022. The former lost nearly a quarter of its value, while the latter actually ended the year up.

Stock market downturns are infrequent. But they can significantly derail the wealth-building process. As such, the average returns over the next 30 years may be lower than what has historically been achieved. In other words, investors may have to wait longer to achieve desired income milestones.

The bottom line

Buying UK shares is far from a risk-free endeavour. But, as demonstrated, it can unlock substantial wealth and accelerate the journey towards financial independence. That, in my opinion, makes these risks worth taking.