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Stuffing a Stocks and Shares ISA with dividend-paying shares is one way to set up passive income streams. It can potentially be lucrative – but how lucrative?
That depends on a few factors. Let’s go through them in turn.
How much to invest
The first is the amount invested. In this example I use £20k. If someone had less, they could use the same approach to earn passive income from a Stocks and Shares ISA, on a smaller scale.
The investing timescale
Next is the question of how long they will invest for. There are two ways of looking at this and they produce different results. The first is simply to take the dividends out as they come.
A second approach is to reinvest them (known as compounding). That would mean no dividends for some time, during which the investment would hopefully grow, increasing the annual flow of dividends down the line for the patient investor.
Dividend yield
To bring that to life, I will introduce another factor that affects how much passive income an investor could hope to generate from a Stocks and Shares ISA, namely dividend yield.
Yield is basically the annual dividends earned expressed as a percentage of the investment. At the moment, the current FTSE 100 dividend yield is 3.4%. In today’s market, while sticking to quality blue-chip shares, I think it is possible to target a 7% yield.
If drawing dividends as they come, a 7% yield on a £20k Stocks and Shares ISA would mean £1,400 in annual passive income. Compounding for 20 years without withdrawing dividends though, the ISA would grow to a point where 7% each year would equal £5,654 in passive income each year.
That example presumes constant share prices and dividends, by the way. In practice, either could move up – or down. That is one reason I think it is wise to diversify across different shares. And £20k is enough to do that.
Finding shares to buy
One share I think investors should consider is Legal & General (LSE: LGEN). The FTSE 100 financial services powerhouse plans to grow its dividend by 2% annually in years to come. Whether it manages to do that depends on business performance. One risk I see is turbulent markets scaring investors and leading them to withdraw funds, hurting profits.
But the company has a large target market, sizeable customer base and powerful brand build over centuries. While earnings have weakened in recent years and the company has a proven business model and is solidly profitable.
Note that I did not start with yield. Remember, dividends are never guaranteed and my primary focus is identifying solid companies with attractive share prices. Only then do I pay attention to yield.
Still, Legal & General’s 9.3% dividend yield is well above the 7% target in my example.
Keeping fees and costs under control
Another variable is how much of the Stocks and Shares ISA gets eaten up with fees, charges, commissions, stamp duty and other costs. So it makes sense for an investor to compare some of the many Stocks and Shares ISAs available when deciding which one is most appropriate for their own circumstances.
This story originally appeared on Motley Fool
