How I’d invest £5 a day in an ISA to earn tax-free passive income for life

Investing little and often in dividend-paying FTSE 100 shares can help me generate the passive income I need to enjoy my retirement.

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A Stocks and Shares ISA is a terrific way to generate passive income from a portfolio of equities, because it’s tax free for life.

I’m looking to build up a reliable and rising dividend income stream by investing in the shares of high-yielding FTSE 100 stocks. Right now, I reckon I’m spoilt for choice, with around a dozen companies yielding 7% a year, or more, and another nine yielding 5% or 6%.

I’m investing regularly

Lately, I have been investing lump-sums, which allows me to take advantage of market dips. Given recent turbulence, there have been plenty of opportunities.

The advantage of investing a lump sum is that it goes to work from day one, giving it more time to compound and grow. Yet investing smaller, regular sums has advantages too.

The obvious one is that it comes out of the income I earn each month. That helps, because I often don’t have a lump sums to hand. Drip-feeding money into my portfolio also allows me to take advantage of the ups and downs of the stock market, because my regular contribution picks up more stock when share prices are down.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Paying in regular sums also keeps my portfolio ticking over. Once I’ve set up a standing order, I don’t give it much thought, but the money keeps building. If I invested £5 a day, this would work out as £150 a month (give or take), and £1,825 a year. It’s not riches, but every little helps.

If I was starting today, I would invest £50 a month into three different high-yielding FTSE 100 stocks. One of these would be Lloyds Banking Group. The banking crisis isn’t over yet, but the Lloyds share price has held steady throughout, suggesting it can survive unscathed.

Lloyds shares currently yield 5.17% a year. Better still, they look cheap, trading at 6.5 times earnings.

Values are tempting today

I would increase my risk slightly by going for Barratt Developments, which currently yields a blockbuster 8.23%. The danger is that a house price crash will hit sales and demand. Yet much of the worry has been priced in, with the stock trading at just 5.4 times earnings.

Finally, I would buy power generator SSE. This has been one of the most reliable income stocks on the FTSE 100 for years, and currently yields 5.01%. It’s more expensive than Lloyds and Barratt, trading at 17.9 times earnings, but that’s cheap by its relatively pricey standards.

The risk with all three stocks is that the share prices could fall, hitting my capital, while dividends are never guaranteed and could be slashed, or even cut altogether. However, this is less of a worry than if I was investing a one-off lump sum. Any dip in their share prices means I would pick up more stock at the lower price. 

With luck, my £5 a day equivalent would roll upwards over time. Plus I would also invest lump sums in other FTSE 100 stocks, when I have the cash and buying opportunities arise.

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.

Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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