Investing in a Stocks and Shares ISA is a brilliant way to generate a regular monthly income stream to supplement my earnings while I’m working and my pension after I retire.
All my income is entirely free of tax for life inside the ISA wrapper, as are my capital gains. Better still, I can use it to invest in my favourite income-generating asset class of all, FTSE 100 shares.
Land of dividends
London-listed blue-chips pay some of the highest dividends in the world. The index currently yields 3.5% a year, more than double the S&P 500 yield of 1.57%, and this is now forecast to rise to 4.2%.
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In practice, I will aim to generate a higher income than 4.2% by investing in individual stocks rather than tracking the entire index. Some top FTSE 100 companies offer amazing yields right now, and better still, many of them look really cheap.
In practice, the two often go together. Yield is calculated by dividing the dividend per share by the share price, so if the stock falls, the yield automatically climbs. A high yield can be a sign of a company with problems, so I would research my stock picks carefully before clicking the buy button and aim to hold for a minimum 10 years to give management time to sort out any problems.
To hit my £125 monthly income target in year one, I would need an average yield of 6.25%. A quick look at today’s FTSE 100 reveals a dozen companies yielding 6% or more. Here are five that spring out.
Mining giant Anglo American yields 6.44% yet trades at just 6.2 times earnings (a ratio of 15 times is normally seen as fair value). Insurer Aviva yields 7.33% and recently rewarded loyal shareholders with a £300m share buyback too.
Good value, high income
Fund manager M&G yields a staggering 9.56%. Its earnings plunged last year due to global stock market volatility but management says the cash will flow this year. Dividends are never guaranteed, so this one is risky, but I think worth it.
I also fancy housebuilder Barratt Developments, which yields 7.38% and trades at six times earnings. I don’t buy tobacco companies, but if I did I’d find the 7.18% yield from Imperial Brands irresistible. It’s also cheap trading at just 7.4 times earnings.
If I split a £20,000 ISA equally between these five stocks, investing £4,000 in each, I would secure an average yield of 7.58% a year. That would give me income of £1,516 in year one, which works out at £126 a month.
Today I would reinvest that income back into my portfolio for growth. With luck, by the time I retire, my dividends could be worth a lot more.
Naturally, there are risks. Any of my stock picks could slash or suspend their dividends at any time. Their share prices could crash, reducing my capital. They could even go bust, in extreme circumstances.
I would get round this by steadily investing in an ISA year after year, building up a portfolio of 15 stocks rather than five. So if one or two disappoint, the rest will hopefully compensate.
