Using a Stocks and Shares ISA to earn passive income in the form of dividends is something hordes of investors do. I am one of them.
With a £20k ISA, I think an investor could target a passive income of £574 per month.
It will take time, though: this is a long-term plan.
Building big income streams
Let me start with some maths, by way of explanation.
Investing £20k at an average yield of, say, 6% could generate £1,200 annually in passive income.
But an alternative approach would be to invest that amount and then reinvest dividends along the way.
That is known as compounding.
At some point of their own choosing, an investor could stop reinvesting the dividends and start taking them as passive income.
Sticking to the example above, compounding £20k at 6% annually for a decade would mean the ISA would be worth around £35,817. At a 6% yield, that could generate £2,149 of dividends, or around £179 per month.
Rolling a snowball downhill
But with longer time horizons, things get even better.
Investor Warren Buffett compares compounding to a snowball going downhill. The longer the hill, the more snow it can pick up.
So in my example above, after 20 years, the monthly passive income would be around £320 per month. After 30 years, it would be £574 on average every month.
Getting the basics in place
Before doing any of that, though, comes the matter of what Stocks and Shares ISA to use.
There are plenty of choices available and I think it makes sense for an investor to consider what one seems most suitable for them. No two investors are identical.
Hunting for high-quality shares to buy
Although I think a 6% yield is achievable even while sticking to blue-chip FTSE 100 shares, it is substantially higher than the average FTSE 100 yield right now.
An example of one FTSE 100 share with an above-average yield I think passive income-hunting investors should consider is Legal & General (LSE: LGEN).
The insurer has a yield of 8.9%. It has grown its dividend per share annually over the past several years and plans to keep doing so, though in practice what happens to a company’s payout ultimately always depends on its financial performance. Nothing is ever guaranteed to last.
Legal & General did cut its dividend following the 2008 financial crisis and I see a risk that that could happen again if financial markets turbulence leads a lot of policyholders to redeem their policies earlier than expected.
But I also see a lot to like here.
The insurance market is huge and Legal & General’s retirement focus gives it a clear strategic direction. It has a proven business model, powerful brand, large client base, and has been consistently profitable in recent years.
I myself own this passive income powerhouse in my portfolio for just those reasons.
