By earning passive income in a Stocks and Shares ISA, investors can use the tax-free gains to fund a more lavish lifestyle. And while it does take a bit of time, a £20,000 lump sum ISA investment is more than enough to get the ball rolling and earn a chunky second income stream, perhaps even up to £18,000 a year. Here’s how.
Establishing portfolio targets
Historically, the stock market has offered a 4% annual return through dividends. But even with UK shares reaching record highs, there are still plenty of income stocks offering yields higher than 6%.
By focusing on these enterprises, a portfolio can match this payout. And at 6%, the amount of capital needed to generate an £18,000, or £1,500 monthly, passive income works out to £300,000.
Obviously, that’s quite a bit more than £20,000. But thanks to compounding, investors can gradually build to this target over time. By reinvesting dividends paid in the short-term and assuming the stocks match the market’s average 4% annual capital gain, a £20,000 ISA portfolio can grow into £300,000 in roughly 27 years.
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.
High-yield opportunities
There are currently 46 stocks across the FTSE 350 offering a dividend yield of 6% or more. That’s a fairly diverse selection of investment options, especially since these businesses span multiple industries and target markets.
However, as every seasoned investor knows, having a high yield doesn’t guarantee high investment returns. In fact, often the higher the payout, the more likely a potential decline is on the horizon, as it’s often an early warning signal of increased risk ahead. As such, it’s critical to carefully scrutinise each opportunity.
For example, Ashmore Group (LSE:ASHM) currently offers a jaw-dropping 9.2% dividend yield, yet the stock has been seemingly stuck on a downward trajectory since early 2021. At least, that was the case until April when its market cap finally started recovering.
A hidden income opportunity?
The emerging markets asset manager has had to endure a rough couple of years, as international investment opportunities in developing markets dried up following global economic slowdowns.
Apart from falling asset prices, weak investor sentiment’s only compounded the difficulties, resulting in a significant reduction in its assets under management today compared to a few years ago. Yet despite this headwind, dividends have continued to flow into the pockets of shareholders.
Management appears to be confident of better times ahead. And to be fair, the firm’s already started seeing client net outflows moderate as emerging market stocks begin to recover. In fact, the MSCI Emerging Market Index is up a massive 37.8% since April – supporting Ashmore’s recent recovery streak.
However, with £120m of dividends being paid out versus only £49m generated from operating cash flow, the group’s using up its financial resources to maintain shareholder rewards. In the long term, this isn’t sustainable. And if the suspected recovery in net client inflows and, subsequently, management fees fails to materialise as expected, a dividend cut could be inevitable.
This risk’s why the yield’s so high. And it’s one that investors must carefully consider when building out a passive income portfolio. Personally, I’m exploring other 6%+-yielding opportunities in the market today.
