Building up a Stocks and Shares ISA to earn passive income from the stock market is something anyone can pursue in the UK. Inside these wonderful accounts, investors can grow wealth and receive income without worrying about paying tax.
What’s more, you don’t have to be Scrooge McDuck to get started. Even a relatively small amount like £7,000 can do the trick. Here’s how.
Dividend yields
To generate £500 in passive income every year from £7,000, a dividend stock would have to yield just under 7.2%.
Unfortunately, it’s not possible to get anywhere near that sort of return from a FTSE 100 index tracker because the index currently only has a 3% yield. This is because the UK’s blue-chip index has been on fire recently, and this has lowered the yield.
So, to achieve higher income, an investor would have to deploy a stock-picking strategy. That is, selectively investing in the shares of individual companies rather than settle for the safety blanket of an index.
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A 7.2% yielder from the FTSE 250
The good news is that the FTSE 250 has a fair few high-yield stocks today. And one that stands out to me is HICL Infrastructure (LSE:HICL).
As the name suggests, this is an infrastructure-focused investment trust. It has stakes in essential public infrastructure projects, including hospitals, railways, and energy networks. From these, it earns steady, long-term payments which it uses to pay dividends to shareholders.
As we can see though, the share price has fallen roughly 32% over the past five years. This reflects the higher interest rate environment, which has impacted the sector. For example, borrowing to fund new projects has become more expensive.
If rates don’t fall as fast as expected (or if inflation spikes and they start rising), the share price could fall even further. This is a key risk.
However, I think the potential reward is worth considering here. Because the forecast dividend yield for the next 12 months is 7.2%, which if met would result in £500 from a £7,000 investment.
Crucially, management is confident the dividend will be met due to solid cash generation from its assets. Top holdings like Affinity Water (the UK’s largest water-only/non-sewerage company) and London St. Pancras HighSpeed (formerly known as High Speed 1) are performing well.
Currently, HICL is trading at a massive 25% discount to its underlying net asset value. To try and narrow this gap, the trust is using proceeds from a series of disposals to buy back shares.
I think investors should consider buying HICL shares to lock in that 7.2% yield.
Diversification
For our purposes here, I’ve just used a single stock as an example. In reality though, it can be dangerous to pile into just one company. It might, say, run into operational difficulties or rising competition could squeeze profit margins. And this may imperil the dividend.
To reduce this risk, it would be a smart move to buy a handful of shares from different sectors. It certainly helps me sleep better at night knowing my portfolio isn’t just a single stock!
But that doesn’t mean one has to necessarily sacrifice high-yield passive income. There are dozens of stocks across the UK market right now offering yields in the 6% to 8% range.
