How I’d use FTSE 100 shares to turn an empty ISA into a bumper passive income stream

With monthly contributions and by reinvesting dividends, our writer shares how they’d aim to turn an empty ISA into a reliable passive income stream.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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The UK’s FTSE 100 is renowned for being home to plenty of high-quality income stocks. It means the index is an attractive place for investors looking not just for capital appreciation, but also for consistent dividends.

These dividend payments can constitute a reliable passive income stream, providing investors with a consistent flow of earnings without the need for much effort. As such, here’s how I’d use FTSE 100 shares to turn an empty ISA into a substantial second income.

The importance of a Stocks and Shares ISA

Before making any purchases, I’d first open a Stocks and Shares ISA. Importantly, this functions as a tax wrapper that can be put around the investments I make within it. To illustrate, any capital gains or dividends I receive from my investments in an ISA are tax-free.

By achieving substantial tax savings over the long run, my investments would grow more effectively, particularly as the compounding process kicks in. This advantageous scenario would likely enhance the overall growth potential of my investment portfolio.

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.

Regularly investing in UK shares

Once I’d opened an ISA, I’d buy 10-20 stocks and continue to invest regularly each month. Moreover, the bulk of my portfolio would be dedicated to high-quality and well-established FTSE 100 dividend shares.

In selecting the companies I wanted to invest in, diversification would be a key principle guiding my approach. For example, by choosing business across various sectors such as finance, technology, and healthcare, I’d be spreading the risk.

That way, if one company or sector underperforms, the impact on my overall portfolio will likely be reduced since other investments may be performing well.

Regular monthly investments (known as pound-cost averaging) would also be pivotal for me. This strategy involves investing a fixed amount at regular intervals, regardless of market fluctuations.

In so doing, I would avoid the almost impossible task of trying to time the market. And that’s been the downfall of many an investor throughout history. Instead, I’d benefit from the natural ebb and flow of the stock market by acquiring more shares when prices are low and fewer when prices are high.

Building a substantial passive income stream

By focusing on income stocks and reinvesting any dividends I received, I would be well on my way to building a bumper passive income. And the more dividends I reinvest, the greater the number of shares I could acquire, thus amplifying my income potential.

For instance, imagine I put £600 each month into my ISA and invested it in shares yielding 8% on average. If I reinvested those dividends, I’d have a pot worth just over £340,000 after 20 years.

Assuming I continue to achieve an average 8% yield on my portfolio of that size, I’d be earning around £27,200 per year in dividend income. That’s not too shabby if you ask me!

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.

Matthew Dumigan has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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