If I had a spare £20k to put into an ISA and wanted to use it to build a sizeable long-term passive income, this is what I would do!
Using money to earn money
In my example, I use £20K. But in fact even if I had less, I would still be happy to put it into Stocks and Shares ISA to try and earn passive income in the form of dividends.
With less money to invest though, my passive income streams would be smaller.
Some try to compensate for a smaller investment pot by buying riskier shares to try and boost their dividends. I think that is a dangerous approach. Whether investing £20k or £200, I would still be looking for the same quality of shares to buy.
The basic principle is that by investing my ISA in blue-chip shares that pay dividends, like Unilever or Vodafone, I could set up passive income streams.
Getting the basics right
There are a few things important to understand before buying a single share for my ISA.
Dividends are never guaranteed. Vodafone has cut its payout in the past and the current high yield (11.6%) suggests the City is nervous another cut might come.
I therefore invest my ISA across a diversified range of income shares.
But I do not just look at the dividend prospects. I also pay attention to valuation. I want to earn passive income – but I do not want to buy shares for more than they are worth. Otherwise I might earn dividends (or not), but see the value of my holding decline compared to what I paid for it.
Aiming for a target
Taking that approach, how much could a £20k ISA realistically earn me?
That depends on the average yield I earn and also my timeline. If I reinvest the dividends at first rather than taking them out as cash (something known as compounding), that could help me hit my target faster.
Still, earning almost £14,000 annually in passive income from an initial investment in my ISA of £20k will rely on a long-term approach to investing.
Imagine I was able to earn an average dividend yield of 8%. That is high but some FTSE 100 shares currently offer such a yield, or even higher. On that basis, in under 30 years I would hit (and in fact surpass) my target of earning £13,999 in passive income annually.
£20k is quite a bit of money to squirrel away for close to three decades. If it could earn me over £1,000 on average in passive income though, I think it could be a very rewarding move for me to make.
