Now is a good time to think about how to earn passive income in 2023 and beyond. One way I plan to do that is by generating dividend income from my Stocks and Shares ISA.
If I had a spare £20,000 in my ISA right now and wanted to target £1,500 next year in dividend income, here is how I would go about it.
Setting a target
If I want to earn £1,500 in dividends per year, that equates to a dividend yield of 7.5% on £20,000.
Earning such a yield while sticking to high-quality, well-established shares is not impossible. But it is high. So I would pay attention to the temptation to sacrifice quality for yield. That can be an expensive mistake.
Instead, I would focus on finding what I think are brilliant companies trading at an attractive price – that also yield an average 7.5%. I would use the £20,000 to diversify my ISA across a range of shares. So some could have a lower yield than 7.5%, as long as the overall average still met my target.
Growth or income
A lot of shares with high yields have limited growth prospects. I think that is okay for me, I just need to be aware of it when setting my expectations.
Take Vodafone as an example. The 9.2% yield is certainly high for a FTSE 100 company with a huge customer base in Europe and Africa. But revenue and post-tax profits were both bigger in 2018 than they were last year. Meanwhile, Vodafone’s big debt pile could mean that the dividend gets cut at some point.
The same applies to Direct Line. Its yield of over 10% is undoubtedly juicy. But insurance is a mature market. Direct Line saw its number of policies in force drop by 9% in the first six months of this year compared to the same period last year. Pre-tax profits fell by almost a third.
Both Vodafone and Direct Line might cut their dividends. However, they may not. They are large businesses with strong brands and big customer bases. What I think matters for me as an investor is to get my focus right. I need to use my ISA to invest in quality companies that also have the sort of yield I want. Simply focussing on yield could lead me to make some costly errors.
Investing my Stocks and Shares ISA
Narrowing down my shortlist in this way, I would select what to buy for my Stocks and Shares ISA.
What if I could not find enough shares to meet my criteria? Then I would wait, investing the £20,000 in stages only as and when I found shares I wanted to own.
Key to my approach is diversification and focussing on identifying quality shares to buy at the right price. I would not sacrifice those principles, but patiently wait to build my passive income streams. Once I found the right shares I think I could hit my £1,500 annual target for dividend income.
