I use my Stocks and Shares ISA for both growth and income. But today, I’m focusing on how I’d turn my next £20,000 investment into pure passive income.
Dividend shares are the key to my plan. Dividend-paying stocks should provide me with regular and reliable income from my investment.
As they’re essentially a share of company profits, I should benefit from owning profitable companies. And, typically every quarter, the cash would hit my account.
Running the numbers
To earn £780 a month in passive income equates to £9,360 a year. That’s almost half the sum of my ISA. Bear in mind that a single £20,000 Stocks and Shares ISA won’t be enough to earn this sum of dividends.
That’s because even the best basket of dividend shares might yield around 8% right now. By my calculations, I’d need a much bigger pot.
But by diligently saving and investing regularly, I should be able to create a large enough ISA within five years.
By investing the maximum possible £20,000 in dividend shares every year for five years, I calculate that I’d potentially build a pot worth over £117,000. That’s a far more realistic sum from which to earn my targeted second income.
An ISA dividend strategy
There’s no shortage of high-dividend UK stocks. But there are a few points to consider when sourcing the best shares.
For instance, the biggest dividend yield isn’t always the best option, in my opinion. For instance, a stock that offers a 15% yield might be hiding some underlying issues.
A jumbo yield might not be sustainable, and company management could decide to cut or suspend the payment.
So if 15% is too high, what’s a good number? Well, I’d consider 6-9% to be an optimum yield for dividend shares.
In addition to its yield, it’s important that investors consider other factors too. As dividends are typically paid from earnings, I prefer companies that offer stable profits and signs of steady growth.
Dividend history is a key component, in my opinion. It can’t guarantee the future, but many years of consistent payments speaks to management’s policy on the matter.
What I’d buy
The simplest way to invest in dividend shares could be to buy a fund like iShares UK Dividend UCITS ETF. It’s made up of around 50 UK dividend shares, and on average it currently yields around 6% a year.
I’d allocate some of my money to this fund. But to reach my target goal, I reckon I’d also need to own some higher-yielding individual shares.
Some FTSE 100 shares that match my criteria right now include Phoenix Group, Legal & General, and British American Tobacco.
If I had spare funds to devote to a dividend income strategy, I’d buy the fund and all three shares. By doing so, I should achieve an average yield of 8%.
That should be more than enough to reach my passive income goals. I’d still need to monitor them in case something drastic changes with any of my companies but, overall, it should be a relatively hands-off approach.
