Have you ever dreamt of earning a passive income, watching the pounds roll in without needing to work for them? Lots of people have the same idea – and many make it a reality by stuffing a Stocks and Shares ISA with blue-chip shares that pay out dividends.
That can be a lucrative approach to earning money without needing to work for it.
Setting a goal that meets your circumstances
The amount such an approach could earn depends on a couple of key variables – how much is invested in the ISA and at what dividend yield.
£1k a month on average requires dividends of £12k a year or more. At a 10% dividend yield, that would already require a £120k ISA. At a 5% yield, the ISA would need to be £240k. Five percent is well above the FTSE 100 yield.
Still, while 10% seems stretching it to me, I think a 7% target yield is realistic in today’s market while sticking to proven blue-chip businesses.
That would require a Stocks and Shares ISA worth a bit less than £172k.
It is possible to start with zero and build up to that, though. How quickly depends on what an individual investor is able to spare.
Such an approach allows an investor to cut their cloth according to their means. A higher or lower target yield would necessitate a smaller or bigger ISA respectively.
Regular saving in an ISA
Doing so within the annual ISA allowance could also allow an investor to keep those passive income streams inside the ISA tax wrapper.
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.
A first move would be to choose the Stocks and Shares ISA that seems best for them. They could then make a regular contribution based on what suits their circumstances.
By reinvesting the dividends at first (known as compounding) instead of withdrawing them as passive income, the investor could aim to reach their target ISA size faster.
For example, if someone invested £500 a month into a Stocks and Shares ISA and compounded it at 7% annually, then after 16 years they would already reach the target size.
At a 7% dividend yield, that ISA would then generate over £1,000 a month in dividends.
All dividends are not created equal
I think a 7% yield is achievable – but it is not guaranteed. That is because a company can cut its dividend whenever it chooses.
Diversifying the ISA across different shares can help manage the risk of a dividend cut. Clearly, it also helps to choose the shares carefully.
One big dividend payer I think investors should consider for their Stocks and Shares ISA is British American Tobacco (LSE: BATS).
Cigarettes are cheap to make. But they command a premium price – and British American’s stable of premium brands like Dunhill help it in that regard.
This simple but powerful model is massively cash generative. British American has raised its dividend per share annually for decades. Currently, the share yields 5.5%.
Cigarette use is declining in many markets. That is a risk to both revenue and profits for the tobacco firm. However, its pricing power helps it try to mitigate the impact of declining sales volumes. Non-cigarette formats like nicotine pouches are also a growth area for the company.
