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A lot of people – me included – use their Stocks and Shares ISA to try and set up passive income streams. That is because many shares pay dividends to their owners.
Such an approach can be lucrative – but not always. Dividends are never guaranteed to last and even when companies do pay them they can be at wildly different rates.
For example, I own shares in JD Sports. Its current yield of 1.4% means £100 invested today would earn £1.40 in dividends annually, if the payout is maintained. But I also own 10.5%-yielding Henderson Far East Income.
So what is a realistic annual income goal for a £20k ISA focused on dividend shares? Let’s consider three different scenarios.
Target: £500 a year
Earning £500 a year from £20k requires a 2.5% yield. That is higher than US indices such as the S&P 500 offer, but is below the current yield of Britain’s FTSE 100 and FTSE 250.
That means even an index tracker might offer that target income (or higher). It might not though: some index trackers pay dividends, but not all do.
Still, I see a 2.5% yield as an achievable goal even while sticking to large, blue-chip companies.
Target: £1,000 a year
What about a £1,000 annual goal? That implies a 5% yield, well above the current FTSE 100 average of 3.1%.
Still, I think that is achievable. It does not even require going beyond the FTSE 100 (though the FTSE 250 contains quite a few interesting high-yield shares).
Quite a few FTSE 100 shares offer yields around 5%, or higher.
One challenge though, is that they tend to be clustered in a few sectors, like tobacco (5.4%-yielding British American Tobacco (LSE: BATS) and 5.5%-yielding Imperial Brands) and financial services (6.1%-yielding Standard Life, 6.5%-yielding M&G, and 7.2%-yielding Legal & General).
That concentration could make it harder to stay adequately diversified. But I think there are enough quality options to make it possible.
Target: £2,000 a year
What about £2,000 in annual passive income? In a £20k ISA that would need a 10% yield – higher than any FTSE 100 share offers.
Some FTSE 250 shares do offer such yields. I mentioned Henderson Far East Income above and there are others, such as TwentyFour Income Fund with its 10.2% yield.
Again though, diversification and proper risk assessment would be needed in trying to construct such a portfolio. Personally, I would not aim for an immediate 10% yield in my ISA. But it is possible to build over a few years, by reinvesting (compounding) dividends.
Compound £20k at 6% annually for nine years and it would grow to a size where a 6% yield then earns over £2k annually in passive income.
A 5%+-yielding share to consider
One share I think merits consideration is British American Tobacco, at least for investors who are ethically comfortable owning tobacco stocks.
The company owns premium brands such as Dunhill and has a massive global distribution network.
Cigarettes are cheap to make but costly to buy. British American therefore generates large cash flows, supporting a dividend that has grown annually for decades.
Will it last? Cigarette sales volumes are declining and I expect that to continue. But sales are still large and pricing power can help the firm mitigate some of the financial impact of lower sales.
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Christopher Ruane owns shares in in JD Sports and Henderson Far East Income.
This story originally appeared on Motley Fool
