Ever thought of tucking some money away in a Stocks and Shares ISA as a way to try and set up long-term passive income streams?
A lot of people do and one advantage I see is that it can be a way to use spare cash when you have some to hopefully produce much more cash later on in life when it may come in handy.
Using the stock market to set up passive income streams
For example, say someone has a spare £20k and puts it into a Stocks and Shares ISA. If they can achieve a compound annual growth rate of 6%, after 20 years the ISA ought to be worth over £32k (the longer the timeframe, the bigger that number should be).
At a 6% dividend yield, that would produce a second income equivalent to around £160 a month. And I reckon 6% is an achievable target even while sticking to well-known blue-chip dividend shares.
Why? Well, currently the FTSE 100 index of leading shares yields 3.1%. A carefully chosen, diversified portfolio of just some of those FTSE 100 shares could yield even higher.
As well as dividends, the compound annual growth rate includes any capital gains. Capital losses could eat into it though, as might ISA charges. So it makes sense to choose carefully when selecting a Stocks and Shares ISA.
What makes a good dividend share?
One mistake some investors make when choosing income shares for their ISA is focusing too much on the current dividend yield. That can be a mistake because dividends are never guaranteed to last. Even successful, highly cash generative businesses can decide to cut them or cancel them.
What is an investor to do? My own approach is to look at the quality of a company’s business and assess its outlook.
I try to consider what sort of free cash flows it might achieve in future and also look at how much (if any) debt it has on its balance sheet.
Some companies also publish a dividend policy although there is no guarantee they will deliver on it. Still, it can be worth considering with other factors, I reckon.
One share to consider
One FTSE 100 share I think merits consideration today is Standard Life (LSE: SDLF). The financial services company has a large customer base of 12m. That gives it economies of scale.
I like its strategic focus on retirement savings and income. That is a massive, resilient market and I expect it to stay that way for decades.
Over a long time, Standard Life has honed a highly cash generative business model. That helps support its dividend policy of trying to raise the payout per share each year.
Currently, at 6%, the Standard Life dividend yield is almost double the wider FTSE 100’s.
Can it last? One risk I see is turbulent financial markets hurting returns while also leading some policy holders to cash in their policies. That could lead to lower profits for Standard Life.
Taking a long-term approach to investment though, I reckon this income share is worth considering.
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Christopher Ruane does not hold any positions in the companies mentioned.
This story originally appeared on Motley Fool
