With a new year for contributing to a Stocks and Shares ISA under way, could now be the time for me to rethink my approach? At the moment, I target both growth and income in my ISA. But if I wanted to try and use it as a vehicle to start generating a four-figure annual passive income, I think I could.
In fact, I reckon I could do that by investing £1,000 a month into a Stocks and Shares ISA in the current tax year. Here is how I would go about that.
Getting ready to invest
First things first. I would start by setting up a Stocks and Shares ISA. Then I would put £1,000 into it each month in the current tax year, starting this month. That would mean that a year from now, I would have an ISA with £12,000 inside it.
That money would be the basis of my income plan. By investing it I would hope to earn dividend income. But I do not need to wait until I have £12,000 saved up to do that. I could start this month, with my first £1,000.
Buying dividend shares
Investing £12,000 over the coming year is one thing – but how could I do that to target an annual dividend income of £1,000?
That comes down to dividend yield.
To earn that much in dividends from £12,000, I would need to invest it at an average yield of around 8.4%. But simply looking at yield could lead me to walk straight into yield traps. That is a share with a high yield that turns out to be unsustainable. The dividend is cut – and the share price falls too, as a result. Ferrexpo is an example of that happening in the past couple of years.
So I always look for great businesses selling at attractive share prices. Only if I find such an opportunity do I then consider its dividend yield.
Target yield
To help reduce my risk, I would invest my Stocks and Shares ISA in a diversified portfolio of shares. That has another advantage, which is that with a variety of shares I do not need all of them to match my target yield. As long as the average yield comes out at 8.4% or higher, it does not matter that some of the shares I buy offer less than that.
So, if I bought shares like M&G, with its 10% yield, and Henderson Far East Income (9.1%), I could still hit my target average while also investing in lower-yielding shares like Legal & General (7.4%).
Sometimes a sector is seen to be risky, pushing down share prices. That can mean yields go higher.
Right now quite a few high-yield UK shares are in the financial services sector, as investors perceive risks from a weak economy eating into profits. So, as well as diversifying my Stocks and Shares ISA across different companies, I would also make sure to spread my exposure across a range of sectors.
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.
