How to create a ton of passive income within an ISA in 3 easy steps

With the right type of ISA, and a little bit of research, an investor can generate quite a lot of passive income today, says Edward Sheldon.

| More on:
Couple working from home while daughter watches video on smartphone with headphones on

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Passive income’s often said to be the ‘holy grail’ of personal finance. With this form of income, investors get paid without having to actively work for the money.

Here, I’m going to explain how UK investors can potentially build up a ton of passive income within an ISA in just a few simple steps. Let’s get into it.

Pick the right ISA

Thanks to higher interest rates, it’s possible to generate passive income within a Cash ISA. At present, some of these accounts are offering interest rates of over 5%.

However, if an investor wants to generate a really high-level income, Stocks and Shares ISAs are a better bet, in my view. That’s because these products offer access to high-yielding investments such as dividend stocks and income funds.

So if I was looking to create a powerful passive income stream, I’d start by opening this type of ISA.

Look for attractive dividend stocks

Once I have an account open, my next move would be to identify some attractive high-yielding dividend stocks.

Now, this part of the process can be a little tricky. This is due to the fact that high-yielding stocks don’t always turn out to be good investments.

Sometimes, a high yield’s actually a signal that the underlying company has fundamental problems. So it’s important to look beyond a company’s yield and think about its long-term prospects.

One dividend stock I like the look of today is FTSE 250 company the Renewables Infrastructure Group (LSE: TRIG). It’s an investment company that owns a portfolio of clean energy assets (wind and solar farms etc).

Looking ahead, the transition away from fossil fuels towards renewable energy is likely to be a huge theme. So the backdrop for this company should be quite favourable.

Currently, the yield here is around 7.75%. This means that a £3k investment could potentially generate annual income of about £233 (dividends are never guaranteed though).

Over the last two years, this company’s share price has taken a hit due to higher interest rates. After this fall, I reckon now’s a good time to consider building a position in it.

That said, there’s always the chance that the share price could dip further. Falling energy prices are one risk to consider with this company.

Diversify to reduce risk

Given that every company has its own risks, the last step in my passive income plan is spreading capital out over a number of different stocks.

This move – which is known as ‘diversifying’ a portfolio – can help to reduce stock-specific risk. This, in turn, can improve the chances of generating strong overall returns.

For example, if you only own three stocks and one of them tanks, your overall returns could be ugly. However, if you own 20 stocks and one falls heavily, it’s probably not going to be so bad.

If you’re looking for more stock ideas to build a diversified passive income portfolio, you can find plenty here at The Motley Fool.

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.

Edward Sheldon has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

More on Dividend Shares

Investing Articles

The FTSE 100’s newest member looks like a no-brainer to me!

This Fool explains why she sees the newest member of the FTSE 100 as a great opportunity after its recent…

Read more »

Investing Articles

Empty Stocks and Shares ISA? Here’s how I’d start earning a second income from scratch

Like the thought of earning extra cash tax free? Our writer explains what he'd do to begin earning passive income…

Read more »

Investing Articles

Is Tesco’s share price still a bargain after rising 26% over a year?

Recent results show Tesco is still growing its leading market share, and despite its share price gains this year, it…

Read more »

Investing Articles

Here’s what the National Grid share price fall could mean for passive income investors

It's long been seen as one of the FTSE 100's best stocks for durable dividends. What does the recent National…

Read more »

Female florist with Down's syndrome working in small business
Investing Articles

£6,000 in savings? Here’s how I’d try to turn that into a £500 monthly passive income

With careful planning and patience, it’s not hard to earn a passive income with UK shares. Here’s one way to…

Read more »

Investing Articles

Here’s how I’d aim for a second income of £1,000 a month, with just £10 a day

How much do we need to build a decent second income? With enough time, we could do it with a…

Read more »

Smiling senior white man talking through telephone while using laptop at desk.
Investing Articles

A top FTSE 250 stock to consider buying for rapid dividend growth!

Looking for dividend shares to target a lifetime of passive income? Here's a FTSE 250 growth stock that could provide…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

3 UK stocks I reckon could benefit from the upcoming general election

As the general election hurtles towards us, this Fool wonders which UK stocks could benefit, and focuses on three picks…

Read more »