A Stocks and Shares ISA can be a way to benefit from long-term appreciation in company valuations, if one makes the right choices. Along the way, though, an ISA can also be a powerful way to generate passive income.
Imagine I had a £20,000 Stocks and Shares ISA and wanted to target an average weekly dividend income of £130. Here is how I would go about it.
Basic investing principles
My first move would be having the money in a Stocks and Shares ISA ready to invest.
Diversification is a simple but important risk management strategy. I would spread my ISA over 10 or so different shares equally to help achieve that diversification.
What sort of shares would I be looking for?
With long-term income as my goal, I would stick to proven blue-chip companies that have been consistently cash generative and I think could continue to be so.
Choosing income shares to buy
An example of such a share I own is British American Tobacco (LSE: BATS).
The company owns premium brands such as Lucky Strike. That gives it pricing power. The market for cigarettes is huge and millions of customers buy regularly, even when the economy is doing poorly.
British American is highly cash generative. That helps it fund a sizeable dividend, which has grown annually for over 25 years.
There are clear risks here. The company’s balance sheet has a lot of debt. A key risk is fewer cigarette smokers leading to declining profits in future.
However, although fewer people than before are smoking cigarettes in many countries, the market remains substantial. British American has also been expanding its non-cigarette business quickly.
Currently the shares offer a dividend yield of 10.2%.
Aiming for a target
A double-digit yield from a FTSE 100 share is the exception rather than the norm.
To hit my target of £130 per week on average in dividends from my Stocks and Shares ISA, I would need to earn £6,760 per year.
From a £20,000 ISA I would not expect to earn that at first. But if I initially reinvested the dividends earned, I could build up to it over time.
To illustrate, imagine that I earned an average 8% yield on my Stocks and Shares ISA – well below what I get from British American, but still slightly over double the FTSE 100 average. Doing that, after 19 years I would be earning over £130 per week on average in dividends.
As a long-term investor, that wait suits me fine. But I could start earning the income earlier by stopping compounding and receiving my dividends as cash, if I was willing to settle for a lower target.
