Putting some money into a Stocks and Shares ISA can help create wealth in different ways.
Maybe the shares will go up in value. Perhaps they will pay dividends that can form passive income streams. Or those dividends could be reinvested (compounded) to buy more shares.
Over time, the income potential could be meaningful.
Income from an ISA
Let me use the example of a £20,000 Stocks and Shares ISA.
If that was invested at a 6.5% dividend yield and compounded at that level for 17 years, it would reach a big enough size that (again, at a 6.5% yield), it would generate an average of £10 per day in income.
That is before considering swings in share prices. They could help the portfolio value grow faster by achieving a higher compound annual growth, although in practice share prices can fall as well as rise.
That is why it is important for investors to select carefully what shares to buy.
Getting serious about the stock market
Finding shares to buy can seem daunting, but I reckon it does not need to.
I limit my search to businesses I understand and then consider their commercial prospects. How big is their target market likely to be in future? What do they have that can work as a competitive advantage to help them benefit from that market? Does it have a lot of debt, or cash, on the balance sheet?
Another thing I always look at is the share price. I do not want to overpay even for a great business, so an attractive valuation is important to me.
None of this needs to be complicated, but I think getting to grips with how investing works and some of the key concepts involved can help an investor achieve more from their Stocks and Shares ISA.
Choosing the best ISA for you
Another piece of homework that can pay off in spades is choosing the right Stocks and Shares ISA.
Different investors have their own priorities — and different ISAs have different charging structures. So comparing some of the options available can help someone find the right one for them.
One income share to consider
Diversifying the £20,000 across different shares is another simple but smart step to reduce risk.
One share to consider for its passive income prospects is British American Tobacco (LSE: BATS).
The demand for cigarettes is declining and that is hurting the company’s sales. I see that as a significant risk for investors.
But what some people forget is that, although declining, cigarette sales remain substantial. I expect that to be the case a decade from now. Meanwhile, British American Tobacco is growing its sales of non-cigarette tobacco products.
Tobacco is a lucrative market, thanks to low production costs and the ability to sell at a high price. With brands such as Lucky Strike in its portfolio, British American Tobacco can command a pricing premium. Meanwhile, its global reach offers economies of scale.
That adds up to serious cash flow generation, in turn funding dividends. The payout per share has grown every year this century although what happens in future will depend on business performance: no dividend is ever guaranteed to last.
With its 7.5% yield (higher than in my example), the passive income prospects are juicy.
