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Passive income has always struck me as the holy grail of investing. A regular payment landing in my account, without me having to lift a finger. Ideally, generated inside a Stocks and Shares ISA.
To generate £888 a month, or £10,656 a year, I’d need to think carefully about what kind of payout I’m aiming for. Many people use the so-called 4% rule, which assumes investors draws 4% a year from a pot without running it down too fast. That would mean needing a hefty £266,400 to hit my income target.
That’s quite a chunk of change. But I think it’s possible to bring that number down a fair bit, depending on the stocks I pick and the yields they offer.
Higher yields, smaller pot
One of my favourite second income stocks is FTSE 100 wealth manager M&G (LSE: MNG). A year ago, it was yielding close to 10%. That’s since dipped to around 7.9% as the shares have enjoyed a strong run.
They’ve climbed 25% over 12 months, and 60% over five years. Not bad for a stock many wrote off as purely an income play. Possibly including me.
M&G isn’t without risk. Markets remain shaky, and the long shift to passive investing is still a threat to its active management model. With interest rates staying higher for longer, income seekers may find cash and bonds more tempting than equity income stocks, where capital is at risk. The dividend is set for modest growth, with the board targeting 2% annual increases.
But there’s still potential. On 30 May, M&G revealed that Japan’s Dai-ichi Life will be taking a 15% stake, bringing an estimated $6bn of new investment into its funds over the next five years. That has given sentiment a lift. I suspect share price growth may slow after its strong run, but I think M&G is still worth considering with a long-term view.
Even so, I wouldn’t pile everything into a single income stock, no matter how juicy the yield. Instead, I’d spread my money around and aim for a more realistic average yield of 5.5%.
Compounding and growing
With a 5.5% yield, I’d need around £193,745 in my ISA to generate £10,656 of annual income and hit that £888 monthly goal. That assumes I live off the dividends, and leave the capital untouched to keep growing over time.
That’s almost £195,000 which sounds like a lot, and it is. But over a 40-year working life, I think it’s achievable. For example, investing just £75 a month at an average growth rate of 7% – roughly in line with the long-term FTSE 100 average – could do the trick.
Naturally, there are risks. Stock markets can go down as well as up. Inflation will nibble away at the buying power of that £888. So I’d encourage anyone with long-term ambitions to save more if they can.
But this shows that with patience, consistency and a little know-how, building a decent ISA income pot is far from impossible. I’d say income investors might consider buying high-yield stocks where the fundamentals still stack up, while diversifying to help smooth out the ride.
This story originally appeared on Motley Fool
