Turning a £20K ISA into passive income worth £10K a year!

Stocks and Shares ISAs have returned 9.6% per year on average in the past decade. That could get me a nice bit of passive income.

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We could all do with a bit of extra passive income in retirement.

And £10k would be a very nice boost every year to my income. Can I do it? Well, if I use a Stocks and Shares ISA, I won’t have to pay tax on my returns. So that’s a good start.

And I’d pin my income plans on good dividends, from top quality FTSE 100 shares.

Some big yields

Investment manager M&G is on a forecast yield of 9.8%, for example. And insurance firm Phoenix Group Holdings offers 8.7%.

With a 9% yield, I’d need around £120k to generate my target of £10k in income per year. And, well, I don’t have that much to invest right now.

But fear not! Using the miracle of compound returns, and investing regularly, I think I can get there.

Albert Einstein allegedly once said: “Compound interest is the most powerful force in the universe“.

It takes time

Did he really say that? I hope so, because then he’d have said one thing that I actually understand. But unless we can get close to the speed of light, we can’t hurry the process of building up our cash.

Ace investor Warren Buffett said that “Time in the market beats timing the market“. And he’s always going on about holding for at least 10 years if we buy a stock.

So, I’d invest the whole £20k per year in my ISA, if I could manage that much, and then save all my dividends to buy more shares.

What could I get?

If the Phoenix dividend yield stays at 8.7%, in 10 years time I could have more than £300k in my ISA from that. That’s way more than I’d need for my £10k target.

And with an M&G yield of 9.8% instead, a decade of investing could get me as much as £380k.

As an aside, these big dividend returns don’t come close to what Warren Buffett has managed. Since he took the helm at Berkshire Hathaway in 1965, he’s achieved an average annual return of 20%.

Hmm, maybe I should forget doing it myself and just buy Berkshire Hathaway shares instead.

Too risky

It would be horribly risky to put all my money into just one stock. The chances of dividend cuts, sector troubles, or my company turning bad are just too high.

So I’d spread my cash around different stocks, and be happy with a smaller average yield. And I won’t have £20k every year to invest, so I’d need that minimum 10-year horizon.

Some folk might go for growth stocks instead, in the hope of making big short-term profits. I used to do that when I was younger, and I had some success.

Better with dividends

But I also had a handful of wipeouts. And over all, I’ve done better since I switched to dividend stocks.

And there’s one bit of statistics that I do like. Over the past 10 years, the average annual Stocks and Shares ISA return has come in at 9.6%.

It might be lower in the future, but it encourages me.

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.

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.

Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended M&g Plc. 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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