Every year, thousands of UK investors start a new Stocks and Shares ISA with the aim of building some passive income.
But how many of us open the account and don’t get round to actually paying in any money for months? It’s July already, and I hold my hand up. Of my new £20k allowance, I’ve used precisely nothing so far.
I need to get started on my empty 2024 ISA. So here’s how I might target an annual income of £40,000 from it.
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Dividend shares
The key to my approach is buying dividend shares and reinvesting the dividend cash every year. It’ll go back into buying more of the same stock, or into a new dividend opportunity. It depends on what’s good value at the time.
How does it work? Let’s look at one of my favourite long-term dividend stocks, Lloyds Banking Group (LSE: LLOY). As I write, after the share price has been rising, we’ve a forecast dividend yield of 4.7%.
There are some much bigger yields on the FTSE 100 today. But I reckon the Lloyds yield could be more typical of the kind of long-term cash I can hope for.
Compounding magic
And forecasters put the Lloyds yield as high as 6.4% by 2026, as they expect the banks to emerge from the inflation crisis and start to grow their profits.
If they’re right, earnings should well cover the dividend in the next few years. And that’s why I’d prefer a dividend like Lloyds’ to a higher yield with poor cover.
We’re talking about something close to the long-term average return from UK shares, which is around 7% a year.
And 7%’s the kind of thing that really could build into a healthy passive income pot, given enough time and the magic of compounding.
How to get there
How much I can make will depend on how much I can afford to invest, and how long I keep going.
That 7% annual return isn’t guaranteed at all. But I think the risk is low enough for me to take, as long as I invest for at least a decade, and diversify among dividend stocks from different sectors.
If I invest as little as £200 a month and keep going for 10 years, I reckon I could end up with a pot of about £34,400. And if I then take my 7% a year from that, I could have about £2,400 a year in passive income.
More ambitious
But I can try harder than that. A total of £500 a month would amount to £6,000 each year. And that’s still way below the ISA limit.
Investing that much each month for as long as 30 years could get me to almost £590,000. I’d be half-millionaire, or something close. And that amount in shares could generate my £40,000 annual income.
We all have different levels of what we can invest in an ISA. But we all start at the same place, with an empty one.
