With the annual contributions deadline for Stocks and Shares ISAs falling next week, I have been thinking about what I could do with an ISA that might make a real difference to my long-term financial position.
One idea would be to target a second income down the line by using £20k invested in dividend shares now.
Doing that, I think I could realistically target an average dividend income of £1,900 a month. That is £22,800 a year.
The basics of the approach
Putting £20,000 into shares now and expecting more than that back in dividends each year might sound impossible.
But that is from a short-term perspective.
If I invest in the right shares, time can be my friend. Over the long term – a timeframe for which I think an ISA can be well suited – I reckon I could realistically aim to turn a £20k sum into a second income of £22,800 each year.
If I reinvest my dividends in buying more shares, I could hopefully build a bigger ISA from my initial £20k investment.
That simple move, known as compounding, could help set me up for substantial dividend streams down the line.
To illustrate, imagine I could compound my ISA value at 9% annually. After three decades it would be worth over a quarter of a million pounds. At that point, a 9% annual return would be over £1,900 each month.
Growth and income
A 9% annual return on its own does not necessarily equate to income. It could come from growth in the valuation of the shares held in the ISA, for example.
So to hit my £1,900 average monthly second income target, at some point I would need an ISA yielding 9%, not just producing a compound annual return of 9%.
But that is in the future. For now, compounding at 9% would be fine, whether that came from share price growth, dividends, or both.
I could look for a certain dividend yield later, when the time comes to receive my second income.
As I explained above, this is a long-term plan. If an initial £20k can turn into a portfolio worth over a quarter of a million pounds and throw off dividend income every year greater than my investment today, I would be happy to wait!
Finding shares to buy
How realistic is a 9% compound annual return over a 30-year period? It is harder than it may sound. But I do think it is possible.
I would diversify my £20k across five to 10 different blue-chip shares. I would be looking to invest in companies like Legal & General (LSE: LGEN).
It currently has an 8% dividend yield, though over the past five years the shares have fallen 7%. The reason I like the share is that I think it has the characteristics of a solid long-term business, currently selling at an attractive valuation.
Operating in a market that is likely to benefit from resilient long-term demand, Legal & General enjoys advantages including a large existing customer base and strong brand.
Wobbly financial markets could lead clients to withdraw funds, hurting the firm’s profits. As a long-term investor though, it has all the characteristics of the type of share I would happily own in my ISA.
