One way to try and build long-term wealth is to invest through a Stocks and Shares ISA. An ISA is also one way I aim to earn passive income, in the form of dividends paid by companies in which I invest.
Doing that allows me to benefit from the commercial success of large blue-chip companies with proven business models.
If I had a spare £10,000 today and wanted to use it to try and earn £900 every year in dividends, here is the plan I would put into action.
Setting up an ISA
My first move would be to choose the Stocks and Shares ISA that seemed best for me. There are lots of options, so I would take time to make my choice.
Then, I would put my £10K into it so it was ready to invest as soon as I found shares to buy.
How to find shares to buy
Finding shares that seemed right for my ISA could make all the difference to whether or not I hit my passive income target.
But I would not start with the income in mind. No dividend is ever guaranteed, so just because a share is paying a handsome dividend today does not mean it will continue to do so in future.
What do I look for, then?
Instead of focussing on what a company pays now, I focus on how it manages to pay it. Does it have a successful place in an industry with high customer demand that looks set to last? Does it have a business model that means sales lead to profits, not losses? How does the company’s balance sheet look – is it loaded with debt or laden with excess cash?
One income share with a long track record of dividend raises
As an example, consider my holding in British American Tobacco (LSE: BATS).
As the name suggests, the company is in the tobacco business. It makes and sells cigarettes in a large number of markets worldwide. Thanks to owning premium brands such as Lucky Strike, it can charge a premium price for its products.
That is helpful to counter the long-term volume decline expected to accompany a reduced rate of cigarette smoking in many markets. I see that as a risk to sales and profits for British American. But I think it may be able to keep doing well. Cigarette sales are falling but remain substantial. Meanwhile, the firm has been expanding its non-cigarette product portfolio in areas such as vaping.
It has raised its dividend annually for decades (making it a Dividend Aristocrat) and currently has a yield of 9.9%.
Building a diversified portfolio of dividend shares
But no matter how good one share may seem, I always make sure to keep my ISA diversified across a few different companies. With £10K, I could comfortably spread the money over five to 10 shares.
To hit my target of £900 per year from the start, I would need to achieve an average dividend yield of 9%.
While that is possible given the high yields of some FTSE 100 shares right now, a lower yield could also work for me. Given my long-term approach to investing, I would simply reinvest the dividends until I hit my dividend income target (something known as compounding). At a 7% average yield, for example, that would take just four years.
