One of the benefits of a Stocks and Shares ISA is that any dividends or profit made from selling a stock are exempt from tax. As a result, it can be a great tool for investors to use trying to build up a passive income stream. For investors starting with an empty ISA, I think they should consider kickstarting things in the following way.
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.
Mixing growth and income
To help speed up the process of reaching five figures worth of annual income from the ISA, I’d suggest focusing on buying stocks that can give both income and growth. This might confuse some people. Yet it’s a misconception that a stock can only offer either growth or income.
Sure, high growth stocks typically reinvest profits to fuel further growth instead of paying it out to shareholders. But there are plenty of companies that are doing very well and still choose to pay out dividends.
By building a portfolio with these type of companies, an investor stands to get the best of both worlds. The regular dividend payments can be banked and reinvested straight away. If the share price continues to rally, profits can be selectively trimmed by selling a small amount of the shares. This in turn becomes a source of income.
The risk with this strategy is that by shooting for income and growth, investors can miss the top performers in each category. For example, the average dividend yield would be lower than if someone purely focused on income stocks. The same is true with growth ideas.
A case study
As an example of a stock that I hold and feel is an all-round player, I like Balfour Beatty (LSE:BBY). The FTSE 250 bank currently has a dividend yield of 2.60%. Yet the stock has risen by 36% over the past year.
The international infrastructure group has a bright future, with strong public sector demand. This includes here in the UK, where a recent trading update noted “the new Government reinforcing commitments to critical national infrastructure.” Over in the US, the new President has also pledged to invest significant sums in construction and similar projects. Balfour Beatty generates more revenue from the US than the UK, so this is clearly going to be a positive for the coming few years.
Some might not be too impressed by the dividend yield. I accept this, but flag up that the dividend per share has been increasing over the past few years. I think this will continue, based on the latest results, so feel the yield will move higher too.
Let’s also not forget that Balfour Beatty is a defensive stock choice. So if in the years to come we have another stock market crash or black swan event, I feel that this company could perform better than some more volatile picks.
Putting the numbers together
Let’s assume that £500 a month was invested in an ISA. The aim would be for an average dividend yield of 4.5%, with share price growth of 9.5%. This means the blended growth rate of the portfolio could be 7%.
If the gains were left to compound, after 15 years the pot could be worth £159.9k. This means that in the following year an investor wouldn’t have to invest a penny more but be able to enjoy £11.2k in income from the portfolio.
