A Stocks and Shares ISA can be a practical way to generate passive income. Not only can the dividends paid by shares add up, but the income may also be tax-free dependent on one’s tax status.
Here is how, over the long term, an ISA with £20,000 in it could be used to target an average monthly passive income of £762.
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.
Choosing the right ISA
It is possible to change a Stocks and Shares ISA along the way, but ideally it would be good to find one that is well-suited to the task from the start. For example, some ISAs have higher fees and charges that can eat into dividends.
So, I think a smart investor will take some time to compare some of the many Stocks and Shares ISAs available on the market.
How the ISA could earn £762 a month
I mentioned above that a £20k ISA could earn an average of £762 each month in passive income.
That involved a couple of assumptions. One was a long-term approach and the other a 7.5% compound annual growth rate. I see that as possible in today’s market while sticking to blue-chip shares.
Compounding £20k at that rate for 25 years, it would grow to almost £122k. At a 7.5% dividend yield, that ought to throw off a monthly passive income averaging £762.
Choosing long-term winners
While some shares could achieve that 7.5% target – or better – many would not.
The growth does not just have to be from dividends. It could also come from share price growth too. But share prices can fall as well as rise.
Diageo is a case in point. The Guinness brewer has raised its dividend per share annually for decades and currently yields 4%. But with a share price fall of 30% in the past five years, it has been a losing proposition for shareholders during that period of time. Will it recover? As a Diageo shareholder myself, I do hope so!
One share I think could perform well in coming years that investors ought to consider now is baker Greggs (LSE: GRG). It too has seen a 30% share price decline, but in just one year, not five.
From a passive income perspective, the yield of 3.5% may look less attractive at first blush than Diageo’s.
But while concerns about declining alcohol consumption pose a risk to Diageo’s future sales, I think Greggs’ market demand is resilient. By expanding beyond breakfast and lunch into dinner eating occasions as it is doing, I reckon Greggs could expand its sales significantly. It is also opening a lot of new shops, another driver I think could lead to higher sales.
The business formula is simple, but I see that as an advantage rather than a bad thing. Greggs has a strong brand, wide distribution, attractive pricing, and uses product innovation to differentiate itself from other bakers and sandwich shops.
A shift in working patterns remains a risk that could hurt revenues, although Greggs is trying to manage that risk by expanding the sorts of sites where it locates its new shops.
