How I’d target a £2k annual second income from my £20k Stocks and Shares ISA allowance

With the Stocks and Shares ISA contribution deadline looming, our writer’s looking at stocks that could help him generate a second income.

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It is now under a fortnight until the annual contributions deadline for a Stocks and Shares ISA.

That is only a deadline for contributing not investing, so if I could maximise my ISA contribution in the current tax year and put in £20k, I do not necessarily need to invest it yet.

However, as I think there are some bargain share prices in the London market right now, I actually would likely invest the money fairly soon too. After all, nobody knows when prices might start to rise again.

If I wanted to use £20k in my Stocks and Shares ISA to target an annual passive income of £2k, here is how I would go about it.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

Investing for the long term

My starting point – and indeed a principle I would aim to maintain – is taking a long-term approach. After all, to achieve a £2k annual passive income on a £20k ISA in the short term would require an average dividend yield of 10%. That is unusually high.

Some FTSE 100 shares offer something close, but the one that tops it (Vodafone) has announced plans to halve its dividend from next year onwards.

All is not lost however. I could invest in shares with a lower average yield – say, 7% — and compound the dividends.

Doing that, after six years, I already ought to be earning £2k in dividends. I could then start withdrawing that as passive income.

Quality on sale

Still, even a 7% yield is well above the average offered by the blue-chip FTSE 100 index at the moment.

So could I achieve it without sacrificing quality? After all, I do not want to buy some duff shares that later cut their dividend and see a share price fall too.

I believe I could. The London market contains quite a few shares that I consider are currently priced cheaply relative to how I expect them to perform over the long run.

A high-yield example

Consider M&G (LSE: MNG). The asset manager has quite a lot going for it in my view. It has a strong brand, a market with sizeable long-term demand and a large existing customer base.

From a dividend perspective too, I think it has appeal. The company’s policy is to maintain or increase its dividend annually.

That is never guaranteed – no dividend is – but since announcing the policy several years ago, M&G has delivered on it. The current yield is 8.4%, significantly more than in assumptions above.

Looking to the future

Whether the dividend can last depends on performance. M&G faces risks such as volatile stock markets hurting returns, or clients withdrawing funds if competitors show better long-term performance.

But if I had £20k in my Stocks and Shares ISA, M&G is one of the shares I would be happy to buy, to try and earn a couple of thousand pounds annually in passive income over the long term.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has positions in Vodafone Group Public. The Motley Fool UK has recommended M&g Plc and Vodafone Group Public. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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