The Stocks and Shares ISA is perhaps the best way for us to start building towards a passive income. Yet relatively few of us have one! Only one out of every six people (16%) in the UK has opened one of these types of investing account. And the average age to start is 43, suggesting not too many are getting started early.
Let’s take that average age as an example. Is a passive income of £30,000 each year possible if starting from an empty ISA? How much would need to be in the account to achieve that?
Short term?
One of the first things a new investor might do is to find a list of FTSE 350 stocks and sort by ‘dividend yield‘. At the top end, we can see some mighty-looking percentages that could return double-digit amounts in the first year alone. Doing it myself, I can see possible yields of 12.94%, 15.41% and 15.69%. Sounds good?
Well, maybe. The highest yields can be rewarding, in the short term at least. But the beauty of investing towards passive income is to look to longer time horizons. Ideally, we want a robust dividend that will keep increasing year after year – even if it isn’t the largest around right now.
Take one of the FTSE 100‘s most popular dividend stocks: British American Tobacco (LSE: BATS). The firm pays a dividend yield of 5.46%, which looks pretty miserly compared to the top of the payout table.
But here’s the trick. It’s a dividend that has been slowly increasing for decades, boosting the return on investment for every year the stock is held. And if those dividends can be reinvested, then it multiplies the effect even further.
Is it worth investing in today? It must be said that the business of selling tobacco is a unique case. Many will want to steer clear for ethical reasons. After all, the company does sell cigarettes. And the consumption of such products has — thankfully for our health — cratered in the developed world.
But this has actually had a huge benefit for the business because of a lack of competition. No entrepreneur is thinking about entering the tobacco biz and there are plenty of regulations to stop new companies from being formed too. I’d say it’s worth considering.
All the difference
Let’s go back to the Stocks and Shares ISA. How much money needs to be put in there to receive a £30k passive income? Assuming we can achieve a regular 5% from dividend stocks, then the amount would be £600k – the kind of lump sum most don’t have laying around.
But hang on a second. Let’s say a 43-year-old wants to start withdrawing at the age of 58. I think that’s a fair time horizon for those looking for a supplemental second income or to help with early retirement. What kind of impact could those 15 years have?
With an average 5% growth rate in dividends over the 15 years, the amount needed to put in the ISA shrinks to £120k (the final balance will have crept up to £339,664 thanks to those compounding dividends). Not bad! And while there are no guarantees to hit the previous numbers – and it does require good selection of dividend stocks – I think it’s a strategy worth mulling over.
