What sort of companies would you buy for a Stocks and Shares ISA?
The answer partly depends on what your objectives are for your investment. I think an ISA can be a good way to build an income stream in the form of dividends. If I am patient, as a long-term investor these could become substantial over time.
Here is how, taking the long view, I could put a £20K Stocks and Shares ISA to work today in the hope of earning £500 on average in monthly income down the line.
Long-term approach
That monthly £500 adds up to £6,000 per year.
On an initial investment of £20,000, that would suggest a dividend yield of 30%. That is improbably high anywhere in the stock market, let alone by sticking to blue-chip names for my Stocks and Shares ISA.
Yet I think I could hit my target without needing to add more money into my ISA — if I was patient.
To do so, I would compound the dividends I earned in the initial years rather than taking them out as cash.
For example, imagine I earned an average yield of 8%. Compounding that annually, after 18 years I would have just under £80,000 in my Stocks and Shares ISA.
If I switched to withdrawing the dividends in cash at that point, I could hit my £500 monthly target.
Power of compounding
Not only does that example explain how I could aim to get to my target, I think it also illustrates just what a powerful tool compounding can be for the savvy long-term investor.
In under a couple of decades, I would almost have quadrupled the value of my Stocks and Shares ISA even without allowing for share price growth.
Shares can go down as well as up, in fairness. But if I bought into great companies at attractive valuations, hopefully their share prices could grow over time. That could further boost the value of my ISA.
What I’m looking for
How realistic is such a hope?
After all, 8% is well above the average FTSE 100 yield – and some shares fall rather than increase in value.
To improve my chances of success, I would focus on stuffing my ISA with great shares that I think are attractively valued.
For example, financial services powerhouse Legal & General currently yields 8.3%. Its share price track record is not great, having fallen 11% over the past five years.
But that puts it on a price-to-earnings ratio of just six. With that sort of valuation, I hope the consistently profitable FTSE 100 company can offer me share price growth potential as well as a chunky dividend.
That might not happen. Choppy financial markets could lead to customers investing less and the Legal & General dividend being cut, as happened during the 2008 financial crisis.
But by buying a diversified range of companies for my Stocks and Shares ISA while weighing risk and reward carefully, I think I could set up substantial long-term income streams.
