A £700 passive income each month – or £8,400 over the course of a year – is a somewhat modest goal in a Stocks and Shares ISA. After all, that is not even close to minimum wage nowadays. Yet looking at common drawdown rates to achieve that goal in an ISA makes the task look daunting indeed:
- 3% yearly withdrawal — £700 a month — £280k needed
- 3.5% yearly withdrawal — £700 a month — £240k needed
- 4% yearly withdrawal — £700 a month — £210k needed
- 4.5% yearly withdrawal — £700 a month — £187k needed
Even if someone does have a six-figure sum of cold hard cashola burning a hole in their pocket, the highest rate in that list is above all current Cash ISA returns and above the average FTSE 100 dividend payout too. Is the notion of earning a sizable passive income impossible for those of us without hundreds of thousands of pounds lying around? Or could there be another way?
Get to grips
It’s no secret that good stock picking inside a Stocks and Shares ISA can supercharge total returns. But the power of compound interest over time is hard to get to grips with until you run through the numbers.
Take a popular FTSE 100 stock like BAE Systems (LSE: BA.). The defence manufacturer has been growing on the back of increased military spending. Many investors like the look of a company on the bleeding edge of state-of-the-art manufacturing.
Hold on a second! The firm pays out a dividend of just 1.78%. That’s lower than savings accounts are offering risk-free. Is it really worth investing in a stock with such a relatively low payout?
Try looking at it another way. The firm pays a dividend of 40p this year. But an investor who bought the stock in 2011 when the share price was 260p is now receiving a 17% yield on the original stake. Forecasts suggest that’s going up next year too.
Long term
In fact, BAE Systems has increased its dividend for over two decades now. Throw in the benefits of an increased share price over the period and you’ve got yourself a very handsome income stream. That’s what we mean when we talk about investing for the long term.
I’ll mention that I’m cherry-picking a good example here. Some dividend stocks are down over the same period. But I think BAE Systems serves as a good reminder that lower dividends can often win out over time. Another lesson here is that the amount needed to put in an ISA to earn passive income can be lower than initially believed.
Is it still a good stock to buy today? I think so, and think it’s worth considering. Some may be put off by the ethical considerations, and manufacturing costs are high in this country these days, but I wouldn’t be surprised if BAE Systems looks like a great stock in another 15 years.
