A Stocks and Shares ISA is a great home for long-term investments. Over 3.5m of us have an ISA, which can be used for capital growth or income generation. With the rise in inflation and the cost-of-living crisis, many are looking for passive income to help ease pressures.
For investors that have an existing ISA, here’s how to hopefully flip it into a cash-generating asset.
Laying the groundwork
I’m going to assume that an example ISA has a pot of £10,000. This is from stock investments built up over the previous few years. Given that over 90% of the FTSE 100 companies currently pay out a dividend, it’s logical that most ISA’s will already be providing the investor with some form of passive income.
The FTSE 100 average dividend yield is 3.64%, so to keep the numbers easy I’m going to base the current annual income from this portfolio at £364. Clearly, this is a long way away from the £5,000 target!
Tweak the focus for new investments
The first step to transforming a normal ISA is considering where to invest new money. Each year, an investor can park £20,000 in the ISA. This will probably be split into monthly or quarterly amounts. For the new cash injections, the focus needs to be away from growth stocks and purely on income ideas.
There’s nothing wrong with growth stocks, but they often provide capital returns, generated from not paying out dividends and instead retaining the money.
Targeting above-average shares will help to pull the yield of the overall portfolio higher over time. For example, there are currently a dozen stocks in the FTSE 100 with a yield of 7%, or higher. I wrote last week about the dividend forecast for M&G and how this could have a yield above 9% for the foreseeable future.
If the next £10,000 has an average yield of 7%, then the total yield will increase from 3.64% to 5.32%.
Keeping up with regular investing
Over time, the focus on dividend stocks will help to raise the average yield on the portfolio. Yet the other benefit of regularly investing is that it increases the size of the ISA. This means that not only am I making my money work harder, but it’s compounding and generating more.
Of course, there are risks involved. Investing a set amount each month (like £500) can be difficult. In the future, unexpected expenses might cause an investor to miss out on putting money aside. Further, dividend yields fluctuate. There’s no guarantee I can reinvest dividends at the same yield as I initially had.
It’s going to take several years to reach £5,000 in annual income. From my calculations, it would take a decade to take a £10,000 ISA to that level. This would include investing £500 each month, with an average dividend yield of 6%. But, ultimately, it shows that by actively changing a strategy, a portfolio can be made to fit any need.
