2 shares that could help turn a £20k ISA into a £2k+ annual passive income machine

By taking a strategic approach to investing his ISA and reinvesting dividends, this writer hopes to build substantial long-term passive income streams.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

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.

One of the things I like about owning dividend shares in my ISA is the dividend income I can earn. That can come in handy as a passive income source. But I could also reinvest those dividends (something known as compounding) to try and boost my long-term returns.

By doing that, I reckon I could try and use a £20k ISA to generate £2,000 annually in dividends over the next six years. Here’s how.

Above-average yields from quality companies

Imagine I invest the £20k ISA at an average yield of 7% and reinvest. Ignoring the impact of share price changes (that could work in my favour, or against), a compound annual gain of 7% would mean that after six years, my 7%-yielding ISA should be large enough to generate over £2,000 in dividends annually.

Should you invest £1,000 in ITV right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if ITV made the list?

See the 6 stocks

At that point, instead of continuing to compound dividends, I could start taking them out as passive income streams.

Seven percent is well above average for a blue-chip FTSE 100 company (the average FTSE 100 firm currently yields 3.6%).

Still, that is only an average. Some shares offer more including what I see as excellent businesses with strong income generation potential.

Finding shares to buy

Diversification is an important risk management strategy. With a £20k ISA, I would aim to spread my money over five to 10 different shares.

To illustrate the sort of shares I think investors should consider buying, I will zoom in on two.

One of them is Legal & General (LSE: LGEN). The FTSE 100 company has a track record of raising its annual dividend frequently. It is aiming annual growth in the dividend per share of 2% over the next few years and already yields a juicy 8.9%.

Created with Highcharts 11.4.3Legal & General Group Plc PriceZoom1M3M6MYTD1Y5Y10YALLwww.fool.co.uk

Still, no dividend is ever guaranteed. Legal & General cut its payout in the last financial crisis and I see a risk the same could happen the next time markets crash if policyholders get nervous and valuations in the firm’s investment portfolio suddenly fall.

But I like the company’s focus on retirement-linked investment products. It is a large market and one I expect to remain that way. Thanks to its focus, industry expertise, and iconic umbrella brand, Legal & General looks well-positioned to benefit from it.

Beyond the FTSE 100

As I said, I like to invest in proven, large businesses. But I do also consider smaller and medium-sized companies, including in the FTSE 250 index.

For example, one FTSE 250 share I think income-focused investors should consider for their ISA is household name ITV (LSE: ITV).

Its current yield of 6.7% is slightly below the target I mentioned above, but as that is an average it could still be hit owning the right mixture of shares yielding over and under 7%.

ITV management aims to maintain the annual dividend per share. But after falling 51% in five years, the ITV share price suggests the City has its doubts.

Created with Highcharts 11.4.3ITV PriceZoom1M3M6MYTD1Y5Y10YALLwww.fool.co.uk

One risk is an ever-expanding universe of digital competitors pulling away ITV’s traditional audience. Still, such competition might actually help ITV’s division that leases studio spaces and offers production assistance.

Meanwhile, it is expanding its own digital footprint and continues to operate a significant legacy business.

But here’s another bargain investment that looks absurdly dirt-cheap:

Like buying £1 for 31p

This seems ridiculous, but we almost never see shares looking this cheap. Yet this Share Advisor pick has a price/book ratio of 0.31. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 31p they invest!

Of course, this is the stock market where money is always at risk — these valuations can change and there are no guarantees. But some risks are a LOT more interesting than others, and at The Motley Fool we believe this company is amongst them.

What’s more, it currently boasts a stellar dividend yield of around 10%, and right now it’s possible for investors to jump aboard at near-historic lows. Want to get the name for yourself?

See the full investment case

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 Legal & General Group Plc. The Motley Fool UK has recommended ITV. 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.

Our best passive income stock ideas

Do you like the idea of dividend income?

The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?

If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…

Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.

What’s more, today we’re giving away one of these stock picks, absolutely free!

Get your free passive income stock pick

More on Investing Articles

artificial intelligence investing algorithms
Investing Articles

Up 272% in just a year, is Palantir stock just getting started?

This writer recognises that Palantir has grown its business very well -- but does the stock price offer him an…

Read more »

Runner standing at the starting point with 2025 year for starting in new year 2025 to achieve business planing and success concept.
Investing Articles

Up 50%? The Aston Martin share price forecast is mind-blowing! 

If analysts are right, the Aston Aston Martin share price could absolutely rocket in the year ahead. Harvey Jones says…

Read more »

Investing Articles

As the S&P 500 drops, here are 2 Stocks and Shares ISA holdings I’m watching

Our writer has different views on how President Trump's tariffs might affect these two US holdings in his Stocks and…

Read more »

Surprised Black girl holding teddy bear toy on Christmas
Investing Articles

£10,000 invested in Tesla stock at Christmas is now worth…

Tesla stock has been one of best-performing investments of the past decade. But things haven't gone to plan for investors…

Read more »

Investing Articles

Up 279% in 5 years, could Meta stock keep soaring?

Meta stock has more than tripled in five years. This writer sees lots to like about the business but also…

Read more »

Pink 3D image of the numbers '2025' growing in size
Investing Articles

25% total return in a year? Is now the perfect time to buy BP shares?

BP shares are on the front line of today's global economic and political uncertainty but analysts think they can still…

Read more »

Affectionate Asian senior mother and daughter using smartphone together at home, smiling joyfully
Investing Articles

With Cash ISA changes coming, could now be the time to consider buying shares?

Changes to the Cash ISA could lead to greater investment in the stock market. This could be a good thing…

Read more »

Investing Articles

These FTSE 100 dividend shares just got cheaper, thanks to President Trump!

Investors buying dividend shares can lock in bigger long-term yields when share prices take a tumble. These two just did…

Read more »