A Stocks and Shares ISA can be a useful platform for a long-term investor.
While some people focus on the potential for share price growth, others use their ISA to generate passive income streams in the form of dividends.
Compounding those dividends can be very lucrative for a long-term investor.
For example, imagine that by reinvesting dividends over time, an investor could increase the value of their ISA by approximately £906,000. That is possible – but how much would it require?
Three variables for long-term dividend income
Asking how much it would require, in isolation, is like asking how long is a piece of string.
There are three variables at play when it comes to forecasting how much an ISA could generate through compounding dividends. Only one is how much is invested. Another is the average dividend yield, while the third is timeframe.
So, for example, a £100,000 ISA compounded for 30 years at an average 8% per year would increase in value by approximately £906k.
The same result could be achieved with less money (but a longer timeframe) or a shorter timeframe (but more money).
Some bargain dividend shares on sale
Is an 8% annual average dividend yield possible? It is over double the current FTSE 100 average, after all.
I think it is. Any well-constructed ISA is diversified across different shares. But with some potential bargains in today’s market, I think an 8% average yield is achievable.
One share I think investors should consider for their ISA is FTSE 100 financial services firm M&G (LSE: MNG).
The demand for asset management is high and I expect it to stay that way over the long term. Thanks to a well-established brand, large customer base, and multinational operations, I see M&G as having some powerful competitive advantages to operate in this space.
M&G aims to maintain or grow its dividend per share annually. It has grown it annually in recent years and the yield currently stands at 9.2%.
One concern I have is that policy holders have been pulling out more than they put in to M&G’s funds in its core business lately. If that continues, it poses a risk to profits.
Choosing the right ISA
In my example above I mentioned an investor with £100k in an ISA. But few investors have that large a sum lying idle. Annual ISA contribution allowances mean it could take years to build up an ISA that had £100k to invest from scratch.
Still, the principles of the above approach hold. It would be possible to ramp up to having £100,000 to invest in the ISA by contributing the standard £20,000 limit for each of five tax years.
Getting the right total return is not just about selecting shares carefully and compounding the dividends, though. ISA costs and fees can eat into the return.
So, a simple first step for the savvy investor is to make a careful comparison of Stocks and Shares ISAs when deciding which one suits their own needs best.
