Buying dividend shares in a Stocks and Shares ISA is a great way to generate a second income. Not only is it a passive way to earn extra cash, but capital gains and dividends from my investments would be awarded tax-free treatment by HMRC.
By selecting a diversified mix of high-yield dividend stocks, I’d target a 7.5% yield on my portfolio. If I used my entire £20,000 annual allowance, that would translate into a second income of £1,500 a year.
Here’s how I’d approach that goal.
Building a dividend portfolio
I’d start my search for dividend investment opportunities by looking at the FTSE 100 index.
On the one hand, London’s blue-chip benchmark has attracted criticism over recent years for being stuffed full of ‘dinosaur’ companies. That’s primarily due to the relative lack of exciting growth stocks and tech companies, compared to US indexes like the S&P 500 or Nasdaq Composite.
On the other, I think there are considerable merits to investing in companies with proven business models and long track records of profitability. After all, many London Stock Exchange-listed firms offer higher dividend yields than their US counterparts.
Here are some examples of high-yield FTSE 100 stocks that I’d consider investing in:
- British American Tobacco — 8.49% yield
- Legal & General — 8.42% yield
- Taylor Wimpey — 7.43% yield
- Vodafone — 9.39% yield
These shares offer market-leading dividends, which makes them excellent passive income picks for my portfolio. In addition, I’d have exposure to a variety of sectors, namely: tobacco, asset management and insurance, housebuilding, and telecommunications.
To complement these dividend stocks and add diversification to my portfolio, I’d also invest in a high-yield exchange-traded fund (ETF).
Vanguard’s FTSE All-World High Dividend Yield UCITS ETF (VHYL) is an attractive choice thanks to its broad global exposure and a dividend yield of 3.77%.
If I split my £20k allowance evenly between these five investments, that would produce an aggregated yield of exactly 7.5%. So, if all goes to plan, I could expect a £1,500 annual second income from my ISA.
Investing risks
It’s important to acknowledge that there are risks in following this strategy. Dividend payments aren’t guaranteed. If any company I invested in suspended or cut its shareholder distributions, I’d earn less passive income than I was aiming for.
What’s more, there’s a risk the share prices could fall, which would reduce the value of my stock market portfolio. Such eventualities could materialise for a variety of reasons from broad macroeconomic factors to company-specific ones.
For instance, British American Tobacco operates in a sunset industry. Legal & General faces competition from a large number of rivals. Taylor Wimpey is confronting headwinds from an increasingly turbulent mortgage market and wobbly house prices. Finally, Vodafone is grappling with a huge debt burden and recently cut 11,000 jobs.
Conversely, the share prices or dividend yields could rise. After all, I believe there’s good upside potential for each of these stocks.
Plus, I invest with a long time horizon in mind. This helps to smooth the ride, as I’m not too preoccupied with short-term volatility. Although there are no guarantees with dividend investing, I think the potential rewards on offer make it an excellent way for me to target a tax-free second income.
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.
