The idea of earning money without having to work for it has an obvious appeal. While passive income may sound like the stuff of fantasy, it need not be. Lots of investors earn it thanks to holding dividend shares in their Stocks and Shares ISA.
Here is an example, showing what such a plan might look like for someone who wants to target £500 a month in passive income.
Aiming for a set amount
That £500 is an average: it would not necessarily come in steady increments, but rather the flow of money would depend on the timing of any dividends received. Dividends are not guaranteed, even for a share that has paid them in the past.
That £500 a month figure adds up to £6k in a year. How large a Stocks and Shares ISA needs to be to generate that amount depends on its dividend yield.
Say, for example, the ISA yields 5%. In that case, to hit the target, it will need to have £120k in it.
Some basic principles to bear in mind
It makes sense to shop around for the most suitable Stocks and Shares ISA. Different investors have different priorities.
The aforementioned £120k is higher than the annual contribution allowance for a single investor. If they do not already have that money in their ISA, they could aim to build up to it over a number of years. As the annual contribution deadline falls this weekend, now could be the perfect time for someone to start!
One way to try and speed up how long it takes to get the ISA to the desired size is by initially reinvesting dividends rather than taking them out as cash. That is known as compounding.
There are a few other things to think about when investing.
Getting to grips with basics like how to value shares and how to diversify an ISA is important. Finding good shares to buy at an attractive price can be more difficult than it might look, and it is a skill that can be honed with time.
Here’s a share to consider
It is also helpful to set objectives.
Some people aim for share price growth. In this example I am focused on passive income instead.
A 5% yield is already well above the FTSE 100 average, though in today’s market I do see it as achievable.
One share I think is worth considering for its income potential is FTSE 100 insurer Aviva (LSE: AV).
General insurance is a fairly dull business – and that is what I like about it as an investor.
The barriers to entry are quite high, due to the capital needed and complex regulatory environment. Demand is resilient and the economic model is long-established.
As the country’s largest general insurer, Aviva benefits from economies of scale. It has a huge customer base and has proven effective at selling many of them more than one type of product.
Aviva has an international business but is mainly focused on the UK. That brings the risk that, if the UK insurance market becomes very competitive and profit margins fall, its earnings could decline.
The current dividend yield is 6.6%.
