As a long-term investor, the investing horizon of a Stocks and Shares ISA appeals to me. Tucking some money away now will hopefully help me to build wealth over the years and decades to come.
But it could also let me earn income along the way, thanks to the dividends that some shares pay.
Here is how, if an investor had £20,000 available to invest in an ISA now, they could aim to earn £27 on average in dividends each week for the rest of their life.
Cash in the short term, without waiting
My own approach to a Stocks and Shares ISA typically involves what is known as compounding. That means reinvesting dividends or gains now, to build a large portfolio and hopefully earn even more down the line.
But an alternative is possible. An investor could simply invest their ISA in dividend stocks today and start taking out the passive income as it arrives.
That means there is not the opportunity for the dividends to compound, as in my portfolio. But it has the advantage that the ISA could start generating dividends in a matter of weeks. This means the investor need not wait for years or even decades to receive them.
An obvious first step is to compare the many Stocks and Shares ISAs that are available on the market and make an informed choice about what one seems most suitable. Not all investors are built the same – and neither are all ISAs.
Focusing on quality first, income prospects second
Average weekly dividends of £27 would require a £20,000 Stocks and Shares ISA to yield 7% on average.
That is over double the current average yield of the FTSE 100 index of leading companies. But I do think it is achievable in the current market, by spreading the money over a diversified collection of blue-chip shares with proven income generation potential.
What is important, though, is not to let the tail wag the dog. No dividend is ever guaranteed to last, so buying a share just because it has a high dividend yield now can be a value trap.
Instead, an investor ought to look at the likely source of future dividends, for example by considering how a business’s free cash flows look set to evolve over time.
Business growth potential, with dividends to boot
As an example of one company I think investors should consider for their Stocks and Shares ISA, FTSE 100 asset manager M&G (LSE: MNG) has a policy of aiming to maintain or grow its dividend per share each year. The current yield is well over 8%.
I like the company’s strong brand, large customer base, and deep experience in the asset management space. One risk that has consistently concerned me of late about the share is the fact that investors were withdrawing more money from the company’s core business than they were putting in.
That remains a risk to profits in the long term, in my view. However, the past week saw news of a big tie-up with a large Japanese financial services company. I think that could help M&G grow.
Meanwhile, it has proven its business has strong cash generation capability – something that can hopefully keep funding the juicy dividend.
