Here’s how I’d target £1,580 in passive income next year using a £20k Stocks and Shares ISA

A Stocks and Shares ISA can be a platform to generate ongoing sizeable passive income streams. Our writer illustrates how he’d try to unlock the potential.

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As June marches on, we will soon be halfway through the year. It may seem early to be thinking about next year already. As a long-term investor, though, at least some of my thoughts are focussed on earning passive income in the form of dividends next year – and hopefully every year. A Stocks and Shares ISA is the sort of long-term investment vehicle I could use to try and bring that goal to life.

Imagine I wanted to target £1,580 of passive income next year from a £20,000 Stocks and Shares ISA. Here is how I would go about it.

Getting ready to invest

My first, practical, move would be to put the money into an ISA so it was ready to invest when I found dividend shares I liked.

So I would look at some of the different Stocks and Shares ISAs on the market and choose the one I felt met my own needs best.

Aiming for a target

To earn £1,580 from a £20K investment, I would need to earn an overall dividend yield of 7.9%.

One approach could be to look through share data and find companies yielding 7.9%. Quite a few do at the moment.

I see a couple of big risks with that approach, though.

Dividends are never guaranteed – what is given as the yield is often the current yield. The future yield may be different. Vodafone has a current yield of 11%, for example. But its prospective yield is under 6%, as the telecoms company has announced plans to slice its dividend in half.

Additionally, although income is my focus, I also need to be mindful of potential capital gain or loss. Investing in a high-yield share that then cuts its payout could also see the share price fall to well below what I paid for it.

All about quality and value

Instead, my starting point would be to find what I think are high-quality companies with strong financial prospects and attractive share prices.

Take Legal & General (LSE: LGEN), as an example. The company, already yielding 9.1%, announced this week it plans to raise the annual dividend per share by 5% this year and 2% annually in the coming three years.

With a strong brand, large customer base, and deep financial markets expertise, I think the company’s prospects are promising. Its updated strategy foresees investing to boost its lifelong personal customer business, as well as merging asset management functions within the firm.

Such changes always bring a risk of disruption and lower staff morale, so I see a risk to earnings in the next couple of years. Hopefully, though, a more focussed Legal & General, investing in areas where it has a strong offering, could help profits grow over time.

Building an income portfolio

if I had a spare £20K in my Stocks and Shares ISA right now, then, Legal & General would be on my shopping list.

To stay diversified, I would spread the ISA funds evenly over five to 10 blue-chip companies with proven business models.

Not all would even need to hit my 7.9% target yield if some, like Legal & General, have a prospective yield well above that.

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.

C Ruane has positions in Vodafone Group Public. The Motley Fool UK has recommended Vodafone Group Public. 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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