The Stocks and Shares ISA in an excellent vehicle for investing. It allows us to invest up to £20,000 a year within the ISA wrapper and any gains, be it dividends or profits from share sales, are free from tax.
That’s why when it comes to passive income generation, the ISA is a great platform for us to use. So how can I go about starting such an ISA, and how can I turn it into a passive income generating machine?
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.
Generating income from investments
Obviously, there are multiple ways to generate passive income. Many of us invest in bricks and mortar and rent out the home. Some of us prefer to put our money into savings accounts.
I don’t have an issue with either of these strategies. But it’s my personal opinion that savings accounts just don’t offer the type of returns I’m looking for, while buy-to-let properties are very much the same. Even if I could achieve a 5% yield on a buy-to-let, there are sizeable mortgage considerations. For me, the maths just don’t add up.
That’s why I prefer to invest in stocks. And the thing is, there’s so much choice. Using online platforms, I can access companies from around the world, from electric vehicle stocks in China to age-old insurance stocks in the UK.
So if I’m trying to turn my cash into a regular income, I can invest in dividend stocks — those that reward shareholders with regular payments.
Right now, I can access FTSE 100 companies with dividend yields in excess of 8%. They don’t offer much in the way of share price growth, but it’s a great way to generate passive income.
But the reality is, if I had £10,000 to invest, £800 a year is about the most I could achieve in passive income — and that would involve investing in firms like Legal & General and Phoenix Group.
A bigger pot for bigger dividends
I may decide that £800 a year isn’t really enough. Instead, I may want to reinvest my dividends year after year and start building my portfolio. I can also contribute more of my own funds to my portfolio. Contributing regularly to a portfolio is a great way to smooth out the peaks and troughs of the market.
For example, if I invested my £10,000 in stocks paying an 8% yield, and contributed £200 a month, while reinvesting year after year, after 25 years I’d have nearly £350,000. That’s the power of compounding.
Of course, no strategy guarantees success, and I could lose money if I pick my stocks poorly. But I’d suggest I could probably do better than just 8%. After all, I normally aim for total returns in the low double digits. If I were able to actualise that over 25 years, it would drastically increase the growth rate. That’s because I’d be earning more interest on more interest.
Time, starting capital, contributions, and growth rate, these are the key variables. Naturally, the more I can achieve in each category, the bigger the portfolio I’ll have by the time I want to draw down. And with a portfolio world £350,000, I could generate £28,000 a year in passive income — assuming I still have 8% yielding stocks to invest in.
But this whole strategy rest on one thing, picking the right stocks!
