A Stocks and Shares ISA can be a useful way to earn passive income. I aim to do that by buying into companies I assess as having good dividend potential.
Given the current state of the UK stock market, I could comfortably aim for a 6% dividend yield while sticking to blue-chip FTSE 100 choices for my Stocks and Shares ISA.
Doing that ought to earn me £1,200 in dividends annually. But if I was willing to take a long-term approach to investing – as I am – I could aim for that much in dividends every month!
Quality on sale is the name of the game
Not only are some shares yielding 6%, a number of FTSE 100 companies yield 7%, 8%, 9% or even higher. Examples from my portfolio include 10.1%-yielding Vodafone and M&G with its 9.7% yield.
Why do I own these shares but not some other FTSE 100 high yielders? After all, dividends are never guaranteed and firms like M&G and Vodafone could both decide to cut theirs.
I own those dividend shares – and others – because I have weighed the risks against the potential rewards I see from their businesses. If I like what I see, I consider buying the shares to hold.
In other words, I never buy a share just for its yield.
Instead, I aim to find great businesses selling at a lower share price than I think they are worth. Only then do I consider the yield.
Building a high-yield portfolio
Fortunately for me, I think the market currently offers me a number of opportunities to invest in great companies at attractive prices with a high yield to boot.
Doing that, buying into firms like British American Tobacco and Legal & General, I believe I could comfortably target an average 8.5% yield while sticking to blue-chip names.
If I did that, I could earn £1,700 in passive income annually.
Compounding to build passive income streams
That would be welcome. But it is still a far cry from my target of £1,200 per month. That equates to £14,400 per year.
To try and achieve that, I would reinvest my dividends initially rather than taking them as cash. The way they then build up is known as compounding.
If I compounded my £20,000 Stocks and Shares ISA at 8.5% annually, after 27 years I would be earning over £1,200 in passive income every month! Of course, I have to accept that might achieve a lower return.
Long-term approach can be very lucrative
I said above that my strategy involved taking a long-term approach to my Stocks and Shares ISA.
My example presumes constant share prices and dividends. In practice, they could move up or down over time.
But I think it demonstrates how buying the right shares and thinking for the long term could potentially yield me large passive income streams in the future.
