£20,000 in cash? Here’s how I’d aim for £10,000 in annual passive income!

Our writer explains how he’d maximise his investment allowance in a Stocks and Shares ISA to target £10k in tax-free passive income every year.

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I try to contribute as much as I can in a Stocks and Shares ISA each year. Because capital gains and dividends on ISA investments are awarded tax-free treatment, it’s an excellent way to earn passive income from the stock market.

If I had enough spare cash to maximise my £20,000 ISA limit in 2024, here’s how I’d aim to turn my initial investment into a portfolio that could yield £10,000 in annual dividend payouts.

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.

Following Warren Buffett

I’m in the early stages of my investing journey. With decades left until retirement, I don’t need to spend my dividend income yet.

Instead, I reinvest my dividends into more stocks. That means I’ll benefit from greater compound returns on my investments over the coming years.

This has been a key ingredient to Warren Buffett‘s stock market success. A great example of the legendary investor’s approach can be found in his purchase of Coca-Cola shares.

He first invested in the soft drinks conglomerate in 1988. Today, the billionaire collects a mammoth 57% yield relative to the cost basis of his original investment. A stunning statistic.

The passive income he earns from long-term holdings like Coca-Cola has helped him to buy plenty of other stocks over recent years. Notable examples are Apple, Chevron, and Occidental Petroleum.

Aiming for income and growth

To follow in Buffett’s footsteps, I need to find dividend stocks for my ISA that offer potential for share price appreciation as well as solid passive income streams.

One that fits the bill for me is FTSE 100 pharma titan AstraZeneca (LSE:AZN).

The company’s track record is undeniably impressive. Over five years, the AstraZeneca share price has more than doubled. In addition, the firm also has a 27-year unbroken streak of dividend growth.

I’m optimistic that AstraZeneca can continue its trajectory for three main reasons.

First, business is booming currently. The company delivered a big earnings beat in its Q1 results. A 19% year-on-year jump in revenue to $12.68bn smashed the City consensus by a whopping 7%. No mean feat.

Second, the firm has a very promising pipeline. To highlight one product with significant potential, AstraZeneca’s drug Enhertu was recently shown to deliver a statistically and clinically meaningful progression-free survival improvement in metastatic breast cancer patients.

Third, AstraZeneca’s valuation looks appealing. The stock’s forward price-to-earnings (P/E) ratio of 17.9 is below its 10-year average of 19.5. This suggests investors who are worried they may be too late to invest should reconsider their assessment.

Granted, AstraZeneca shares aren’t risk-free. One pressing concern is the company’s recent admission in court documents that its Covid-19 vaccine can cause a rare blood clotting syndrome. This poses legal and reputational risks that could damage future returns.

Nonetheless, the overall risk/reward profile still looks attractive to me.

Generating passive income

From a diversified portfolio of dividend stocks like AstraZeneca, I could aim for an average annualised return of 8%. Of course, this isn’t guaranteed and my returns are unlikely to be linear.

Nonetheless if I did achieve this, £20k compounded over 30 years would result in a portfolio worth just over £200k. At an average 5% yield across my dividend shares, I’d be earning £10k in passive income every year!

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.

Charlie Carman has positions in AstraZeneca Plc and The Coca-Cola Company. The Motley Fool UK has recommended Apple, AstraZeneca Plc, and Occidental Petroleum. 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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