Why I’d invest £5,000 now in UK shares in an ISA to make a passive income

Investing £5,000, or any other amount, in UK shares through an ISA could offer a generous passive income and capital returns, in my view.

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Making a passive income from UK shares has become more difficult over the last year. The coronavirus pandemic prompted financial uncertainty for many companies across the FTSE 350. This resulted in reduced dividend payouts, or even a cancellation of dividends in some cases.

However, the economic outlook is set to get better. This may mean improved performances for many businesses that lead to higher dividend payouts. Alongside the capital growth potential of UK stocks, this could make now the right time to invest £5,000, or any other amount, in a diverse selection of income shares in an ISA.

Buying UK shares to make a passive income

Despite many UK shares cutting their dividends, it is still possible to make a generous passive income from FTSE 350 shares. In fact, both the FTSE 100 and FTSE 250 trade lower than they did a year ago. As such, some of their members have share prices that are down on their previous highs. This could mean that they now offer higher yields than they did a year ago – as long as they have been able to maintain their dividend payouts.

This could mean that it is possible to obtain a 4% or 5% average yield from a portfolio of UK stocks. In a low-interest-rate environment, this could be a relatively high income return. It also has the capacity to rise at an above-inflation pace over the coming years. The world and UK economies are widely forecast to recover strongly as vaccine rollouts continue. This could prompt improving operating conditions for many UK shares that allow them to pay higher dividends over the long term.

UK stocks could offer capital growth

Investing £5,000 in UK shares could also be a shrewd move because of their capital growth prospects. Many FTSE 350 shares trade on valuations that are significantly below their historic averages. This could signal that they offer wide margins of safety that produce relatively high returns. Since the stock market has historically reverted to its long-term average values, buying today’s cheap shares may be a profitable move.

Doing so through a tax-efficient account such as a Stocks and Shares ISA could offer further improvements to returns. The lack of capital gains tax or dividend tax charged on investments in an ISA may widen the gap in total returns versus a bog-standard share dealing account.

Risk management

Of course, there is never any guarantee of a passive income or capital growth from a portfolio of UK shares. They could experience very tough operating conditions in future that are not fully reflected in their current valuations.

However, with dividends forecast to grow in the coming years, yields being high in a low-interest-rate environment and the economic outlook expected to improve, UK stocks could offer impressive total returns in the long term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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