The long-term timeframe of a Stocks and Shares ISA is one of its attractions to me as an investor.
When it comes to passive income, that can mean taking some time to build up sizeable dividend streams before taking them out each year in cash.
£1K+ annually from a £9k ISA
As an example, consider an investor who has a spare £9K available to put into a Stocks and Shares ISA.
The first move, of course, would be choosing the right Stocks and Shares ISA to put the money into. Like most investors, I prefer the dividends from my ISA to provide me with extra income rather than funding a stockbroker’s luxury lifestyle.
Investing the money and taking the dividends right away when they come in is one option. At an 11.1% yield, a £9K Stocks and Shares ISA would be generating £1,000 annually in passive income.
But an 11.1% is not currently a realistic dividend yield from a diversified portfolio of FTSE 100 dividend shares. The index’s highest-yielding member is Phoenix Group, which offers 10.3%. But many are lower.
Take two: £1K+ a year from a £9K ISA
Back to the drawing board.
An alternative would be to invest in lower-yielding shares (still well above the FTSE 100 average of 3.5%, though) and reinvest the dividends initially, an approach known as compounding. At some point, dividends could then be drawn out as cash.
To illustrate: if the investor compounds the £9K at 8% annually, after five years the Stocks and Shares ISA should be worth around £13,224. At an 8% yield, that ought to produce passive income streams of around £1,058 annually.
Building a portfolio of quality dividend shares
Remember, that 8% number is net. In other words, it is after the fees and costs of the Stocks and Shares ISA. As I said earlier, you can see why choosing the right ISA is important.
How achievable is an 8% yield from a range of quality shares?
In today’s market, I think it is achievable. I say “range” as I would not want to put all my eggs in one basket. Instead I would keep my ISA diversified. No dividend is ever guaranteed to last.
As an example, British American Tobacco (LSE: BATS) is one that might be worth considering for a place in such a portfolio.
The FTSE 100 firm has raised its dividend per share annually and plans to keep doing so. Currently, the dividend yield on offer is 7.7% (the 8% target is just an average, so an investor could aim to hit it with some slightly lower-yielding shares balanced out by some more lucrative ones).
Will that last? Plans are only plans, after all.
Cigarette volumes are declining in many markets. Owning premium brands like Pall Mall gives British American pricing power it can use to help offset lower volumes, but in the long term I do see declining cigarette usage as a big risk to profits and revenues.
British American obviously does too, which explains why it has been building its non-cigarette business at speed.
Meanwhile, the company remains highly cash generative. It has a strong brand portfolio, global distribution network and economies of scale. Keeping cash generation strong is important as it can help keep those juicy quarterly dividends flowing.
