One way I use a Stocks and Shares ISA is to generate a passive income. That lets me benefit from the success of blue-chip companies without needing to do the hard work myself. Over the course of time, I think this approach could prove to be fairly lucrative.
If I had a spare £20k today to invest in a Stocks and Shares ISA with the objective of generating a second income of £3,815 a year, here is the plan of action I would adopt.
Choosing the right ISA
My first move would be to pick a Stocks and Shares ISA that suited my personal financial circumstances. There are lots of different options available, so I would want to pick the right one for me.
I could then put my £20k into it and get ready to start investing.
Setting a strategy
Next I would decide how I wanted to invest the money. If I was a novice investor, it Is at this point that I would learn the basics of how the stock market works.
Then I would decide my strategy. That does not need to be complicated, but I think having a sense of what I want to do could help guide my investment choices.
In all cases I would be looking for a great business selling at an attractive valuation. Only after establishing that would I then consider the dividend yield.
Finding shares to buy
Even the best business can run into unforeseen difficulties however, so I would diversify my ISA across a number of different shares. With £20k, I could comfortably spread my choices over five to 10 shares.
I would stick to business areas I felt I understood, so I could assess the prospects of the businesses in which I was thinking about investing.
The sort of income share I own in my portfolio is British American Tobacco (LSE: BATS). I like the multinational tobacco manufacturer’s portfolio of premium brands, its strong market position and large customer base. The company is a free cash flow machine and has raised its dividend annually for decades.
Hopefully, the juicy yield of 9.7% may not even fully reflect what I earn, if the dividend keeps growing.
But with cigarette sales declining and British American having a lot of debt, the dividend could go into reverse at some point and may even be cancelled if things get bad enough.
This illustrates why, as an investor, I need to consider seriously the risks of a share before I buy it. My hope for British American is that cigarette sales decline but still continue for decades, while the business grows its non-cigarette business.
Targeting income
Investing a £20k ISA at an average yield of 9.7% should earn me £1,940 in dividends annually. If I reinvest the dividends at first though, a 9.7%-yielding £20k ISA ought to let me hit my second income target of £3,815 annually after seven years.
If my average yield was lower, I could still aim to follow the same strategy but it would take me longer to hit my target.
