One way to earn passive income is to buy shares in companies that pay dividends. That can turn a Stocks and Shares ISA into a source of ongoing income.
How lucrative can that be? The answer is: it can produce thousands of pounds in income a month. But whether that happens depends on two or three factors.
Factors that determine income
First is how much money is invested. The second factor is at what dividend yield. Third, timeframe can have a role. Maybe someone has enough spare cash to start earning their target income today.
But if not – indeed, even if their ISA is empty today — they can build towards their target over time.
For example, if an ISA yields 5%, a £2k monthly passive income (£24k a year) would require funds of £480k. But rather than putting that money in straight away, someone could invest what they can afford each year and reinvest the dividends (known as compounding) to build the size of their ISA.
Starting from nothing and investing £20k a year would take 17 years before the Stocks and Shares ISA is worth over £480k. That would be big enough to generate an average £2k a month in passive income at a 5% yield.
Making smart choices
Although I am presuming a 5% yield, that is just an example. At a lower yield, more money would need to be invested. A higher yield could require less money in the ISA to generate the same passive income.
But does that mean that an investor ought to chase high yields? Not necessarily!
No dividend is ever guaranteed to last so it is important not just to look at the dividend today but also how likely the company is to pay it in future.
Another factor that can impact the returns earned from such a passive income plan is the costs and fees of the ISA. A savvy investor ought to consider their options when it comes to choosing the right ISA for their needs.
Here’s a dividend share to consider!
One share I think investors ought to consider for its passive income potential is FTSE 100 manufacturer British American Tobacco (LSE: BATS). The company owns premium brands such as Lucky Strike. That, combined with the addictive nature of nicotine, gives it pricing power. British American can use that pricing power to generate sizeable cash flows, supporting its dividend.
The current dividend yield is 5.6%. The company aims to keep growing its dividend per share annually, as it has done for decades.
Will that continue? The company is wrestling with declining cigarette sales volumes. I see that as an ongoing risk. Still, with its pricing power and growing non-cigarette business, I think British American may be able to manage that risk to profit successfully over time.
