Dividends are a phenomenal way to unlock a second income. Instead of spending countless hours on a side hustle or going into debt with buy-to-let, investing is a rewarding and time-efficient alternative. And with inflation driving up the cost of living, having a second income stream in 2024 is now more critical than ever.

With that in mind, let’s explore how to transform a £20k ISA into a cash-generating machine.

Earning a £5,000 investment income

A Stocks and Shares ISA opens the door to tax-free returns for British investors. With both capital gains and dividend tax allowances being cut in recent years, capitalising on the advantages offered by an ISA’s a no-brainer. But even if an investor’s fortunate enough to maximise their £20,000 limit in 2024, it still leaves a giant question mark over where this money should be invested.

The London Stock Exchange is filled with hundreds of dividend-paying enterprises. So investors are spoilt for choice. But that also makes it harder to pinpoint exactly where this precious capital should be allocated.

Let’s start by simply setting a target of earning £5,000 a year from dividends. The FTSE 100‘s historically sat between 3% and 4%. And through some prudent stock picking, this yield could realistically be initially boosted to 6% without taking on excessive extra risk with stocks like ITV (LSE:ITV). At this rate of dividend income, a £20k ISA would only produce £1,200 a year.

That’s nothing to scoff at, but it’s a far cry from £5,000. So how do we fix this?

Enter compounding

Instead of enjoying dividends from day one, investors can opt to automatically reinvest them through Dividend Reinvestment Programmes (DRIPs). These often come paired with lower fees and, in some instances, discounted prices.

As a result, the compounding process is accelerated. And assuming a portfolio can muster the market average annual capital gain of 4%, it would take roughly 14 years to expand the ISA second income to £5,000. And if I were able to contribute a further £500 each month, this timeline could be drastically shortened to just six years.

Finding winning stocks

Considering ITV is in the film and TV streaming business, it sounds more like a growth stock rather than an income opportunity. And while it certainly seems to share the volatility of a growth enterprise, this has also led to a rise in its dividend yield in recent years.

The company’s revenue stream consists of monthly subscriptions as well as advertising income. Both are recurring in nature, paving the way for ample cash generation, which is how the firm has maintained shareholder payouts even after committing billions to the creation of new content.

While there have been a few hiccups following writer strikes in the US, the group’s been successfully delivering significant cost savings to offset the impact on profits. But there’s still the risk of wasted money if its investment into new content doesn’t translate into quality that’s popular with viewers.

ITV isn’t the only 6%-yielding opportunity worth researching right now. And there may be lower-risk alternatives for investors to consider. Regardless, keeping risk in check with tactics like diversification will always play a crucial role in building a sustainable second income from an investment portfolio.