How could an investor use £20,000, an ISA, and 5 dividend shares to target annual income of £3,225?

Our writer describes how a relatively modest level of savings could be invested in a handful of dividend shares to generate a second income stream.

| More on:

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.

There are plenty of dividend shares around at the moment. I reckon 83 stocks on the FTSE 350 are presently offering yields in excess of 5%.

Impressively, if this level of return could be achieved by an investor for 25 consecutive years, an initial investment of £20,000 would grow to £67,727. And after a quarter of a century, the portfolio would generate income of £3,225 a year, or £269 a month. Not bad for doing very little.

I chose £20,000 as a lump sum in my example because this is the maximum amount that can be invested each year in a Stocks and Shares ISA.

The principal advantage of this type of investment vehicle is that all gains and income are earned tax-free.

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.

However, it must be pointed out that dividends are never guaranteed. And any investment can go down in value, without warning.

Spreading the risk

That’s why diversification is important. Putting this hypothetical £20,000 into just one stock wouldn’t be a good idea.

Of course, an investor could be lucky and choose one that soars in value. But there’s also the possibility that they’d pick one that underperforms the wider market.

There are no hard and fast rules when it comes to choosing how many stocks to buy. But it’s a mathematical certainty that the more shares an investor has in their portfolio, the closer the return’s likely to be to the market average.

My approach

Personally, I think, with £20,000 available, that investing in five stocks makes sense.

And I’d target the many UK shares that have paid generous dividends for several years.

One of these is Legal & General (LSE:LGEN). Over the past 25 years, it has only ever cut its dividend during the 2007-2008 financial crisis. For 2024, it’s promised to pay 21.36p a share, which is a 5% increase on 2023. This means the stock’s presently yielding a rather impressive 9.2%.

And the company has pledged to increase its payout by 2% a year, from 2025 to 2027.

The stock remains on my watchlist for when I next have some spare cash. That’s because I think the company is well positioned to maintain its strong payout, and continue to grow it over time.

The group currently has a pipeline of £14bn of third-party pension schemes that it’s looking to acquire. In 2023, it achieved a return on equity of 9.7%. Let’s say it manages to secure ‘only’ a third of these retirement plans and repeats its 2023 return — annual earnings would increase by at least £450m. For context, its adjusted operating profit in 2023 was £1.67bn.

Legal & General is also financially robust, holding more than twice the level of reserves that it’s legally obliged to have.

Other considerations

But there are risks. The company has £197bn of equities, and nearly £10bn of investment properties, on its balance sheet. Any stock market or property market wobbles are therefore likely to have a huge impact.

The company also faces stiff competition. This could explain why its assets under management fell by 2.9%, during the 12 months to 30 June 2024.

However, despite these potential challenges, I remain a fan of the stock. And I reckon it shouldn’t be too difficult to find another four UK shares — with above-average yields — that would complement Legal & General in a diversified and well-balanced portfolio.

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.

James Beard has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

More on Investing Articles

Young Caucasian woman with pink her studying from her laptop screen
Investing Articles

Time to buy Nvidia shares before fresh all-time highs?

Nvidia shares began 2025 at an all-time high before a big drop in the last week or two. Our writer…

Read more »

Investing Articles

A top FTSE 100 share to consider for a Stocks and Shares ISA starter portfolio!

While not without risk, a lump sum in this FTSE 100 trust could prove a great way for Stocks and…

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

I asked ChatGPT to name the best 5 UK shares to build wealth over 50 – and here they are!

Harvey Jones is looking to build a balanced portfolio of UK shares to fund his final years, and asked ChatGPT…

Read more »

Investing Articles

£10k invested in Scottish Mortgage shares after the DeepSeek crash is now worth…

Harvey Jones thought his Scottish Mortgage shares were heading for a bumpy ride when DeepSeek emerged last month. Then he…

Read more »

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

1 ex-penny stock up nearly 400% in my Stocks and Shares ISA! 

This writer is starting to take notice of a small-cap stock that is 'up' significantly in his ISA portfolio over…

Read more »

Investing Articles

The FTSE 100 index hits new highs! But will Legal & General shares outperform it in 2025?

Legal & General's share price has rocketed almost 8% so far in 2025. Can it continue to outstrip the surging…

Read more »

Investing Articles

Up another 8% in a week! So what’s stopping me from buying IAG shares? 

Harvey Jones is desperate to add high-flying IAG shares to his portfolio before they climb even higher but there's a…

Read more »

Happy couple showing relief at news
Investing Articles

The Bank of England’s slashed its growth forecast but the FTSE 100 doesn’t seem to care!

On the day the UK’s central bank halved its forecast for growth in 2025, the FTSE 100 reached a record…

Read more »