Using a Stocks and Shares ISA to generate passive income is hardly a novel idea. After all, thousands of people already do exactly that.
But just because an idea is obvious and proven does not mean it is not powerful.
Indeed, often a straightforward, obvious idea can be better than an overly complicated one. I think earning passive income by stuffing a Stocks and Shares ISA with blue-chip stocks could be just like that.
Some basics of earning dividends
The passive income would be in the form of dividends. But not all firms pay dividends.
Even those that have been generous payers in the past can cut them at any moment. So I would spread my Stocks and Shares ISA across a range of choices. With £20k to invest, I would probably plump for five to 10 different shares.
I would set up the Stocks and Shares ISA now, even if I did not yet know what I wanted to buy. That way, I could park the money in it and be ready to invest the moment I have what I see as a compelling investment opportunity.
Aiming for a target income
To earn £1,820 of passive income in a year, I would need to generate an average yield of 9.1%.
That is high. The average FTSE 100 yield is around 4%. That is only an average however, and some shares pay little or nothing. So at the other end of the spectrum, there are various blue-chip shares yielding close to 9%, or in some cases even more.
From my own portfolio, for example, M&G yields 9%, British American Tobacco yields 9.7% and Vodafone offers a whopping 11.6%. There are other high-yield FTSE 100 shares I do not currently own, like Phoenix with its 9.8% yield.
If I bought some shares with a yield above 9.1%, I may still be able to buy other shares yielding beneath that level yet still hit my overall target.
Quality street
Not only that, but I need not limit myself to the FTSE 100. I could buy other shares too if I chose.
The point is, whatever I decide could be the right choice for my Stocks and Shares ISA, I would not do that by looking only at yield. That may lead me into a trap, where a company that can no longer afford its dividend cuts it – and the share price plunges in response.
Instead, I would focus on finding what I see as outstanding businesses with attractive share prices.
To do that, I would consider things like the size of the market, how a firm’s business model differentiates it from competitors, what debt it has (if any) and also how enthusiastic the board is to use surplus cash to fund dividends.
If I can find the right quality of shares trading at a decent price, I think I could realistically aim to turn a Stocks and Shares ISA into a passive income machine throwing off over £1,800 each year from 2024 onwards.
