One of the reasons I invest money in a Stocks and Shares ISA is because of the income potential this offers me. I can put money into my ISA, buy shares and then benefit from any dividends the companies pay.
Doing this could turn out to be fairly lucrative – if I make the right choices.
Here is how I would use a £20,000 ISA to try and target close to £2,000 in dividend income annually.
Yield matters
The two factors that determine how much I might earn in income from owning shares are the amount I invest and my average dividend yield.
With £20,000 as a fixed number in my example, the factor that will impact my expected earnings is the average yield I generate.
To get £2,000 in income from my Stocks and Shares ISA each year, I would need to build a portfolio yielding 10% on average to hit my target. Of course, a risk is that I don’t achieve this if my chosen stocks underperform. But I could still achieve my income goal by adding more cash and stocks to my ISA.
Keeping to that £20k ISA plan though, one important risk management strategy is diversification. Owning a range of shares means that not all of them need to yield 10% for me to hit my target as long as some of them do.
Avoiding value traps
As an investor, I do not buy shares just because they offer a high yield as very high yields are not reliable. At different points last year, for example, Persimmon and Ferrexpo both offered yields much higher than 10%. Yet Persimmon cut its dividend and Ferrexpo has stopped paying out altogether.
Instead, I focus on finding great businesses with attractive share prices.
If I can avoid yield traps, I think a percentage dividend yield in the high single digits or low double digits is feasible. Currently in my portfolio, examples I own include British American Tobacco and M&G.
Other shares I have been eyeing for my Stocks and Shares ISA lately also offer me a similar yield. For example, the Income & Growth venture capital trust yields just under 11% at the moment.
Patient investing
But another important element to my approach is being willing to wait before buying a stock. That fits with my long-term investing strategy.
The reason that can help is because the lower a price I pay for a share, the higher its dividend yield would be (if the dividend is maintained). For example, I think Legal & General is an attractive business and would happily add it to my Stocks and Shares ISA if I had spare money to invest. Buying it today would offer me a yield of 8.5%.
But Legal & General shares are 13% more expensive now than at their lowest point over the past 12 months. If I had bought back then, I would now be earning a yield higher than 8.5%.
If I am patient and wait for real bargains, that could help me hit my dividend target.
To do that, though, I first need to identify some great businesses in which I want to invest. Then I will be ready to add them to my Stocks and Shares ISA once their prices hit an attractive level.
