Opening a Stocks and Shares ISA makes perfect sense to me if I’m trying to build a second income stream for life. Thanks to its tax-efficient status, I pay nothing on any dividends I receive.
The question is, what do I fill it with if I had £20,000 to put to work? Well, no two investors are the same. But I can tell you exactly what I’d be looking for.
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Increasing the odds
From the outset, I must remember that no income stream is guaranteed. But I reckon there are a few simple ways of increasing my chances of getting paid every year.
First, I try to identify companies in resilient parts of the market. One example of this would be healthcare. It’s just a fact of life that all of us will get ill from time to time and require treatment. This means that earnings will stay pretty steady for companies operating in this sector.
The same goes for utilities. We all need access to gas, electricity and water.
A third industry I like is consumer goods — those things we buy out of habit or necessity. Food and drink are the obvious examples. Contrast this with luxury or tech goods where demand might wax and wane.
What I’m looking for
Having identified the most stable industries, I need to pick the best stocks within them. There are a couple of things I look for, both of which can often be found in a firm’s annual report.
For example, I want to see some evidence that a company has a decent history of delivering passive income. The odd missed year is acceptable, but consistency is the name of the game. Encouragingly, some UK stocks have paid out for decades without a gap.
I also like firms that have a track record of increasing dividends every year. As well as sending a message that trading is healthy, this can help to reduce the impact of inflation.
Don’t get greedy
At this point, there’s a really important thing I need to highlight. Neither of the things mentioned above tell me anything about whether a business will continue to send me cash. It’s for this reason that spreading my ISA allowance around the market remains a priority.
This is particularly the case if I’m seeking above-average dividend yields. As many experienced Fools will know, what looks too good to be true often is.
There’s no perfect percentage here. However, anything over, say, 6% would push me to do some extra research and check it’s likely to be paid.
And if all this sounds like too much work, there is another option. An index fund that just tracks the market returns (like the FTSE 100) will also generate income.
The first step
Few people — including me — have £20,000 hiding down the back of the sofa. But that’s not the point.
Owning a single share in a company still means I’m entitled to dividends, assuming it has a policy of distributing this cash (some companies will prefer to use it for other things).
This is why it makes sense for me to use up whatever amount of my ISA allowance I can.
The first step is always the hardest, but what better time to get started than right at the beginning of the year?
