Using a Stock and Shares ISA for passive income can be a winning long-term investment strategy. All the dividends an investor receives are protected from tax. And investors can buy a wide range of shares, funds, and trusts to build a diversified and resilient income stream.
Fancy making a life-changing monthly second income in an ISA? Here’s one strategy I believe you should consider.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Diversifying your ISA
Investing in individual shares is a great way to target long-term wealth. The problem is, even the most reliable dividend share can slash, postpone, or cancel shareholder payouts altogether when times get tough.
The most famous recent example is Shell. In 2020, it cut dividends when the Covid-19 pandemic arrived and oil prices tanked. Why was this shocking? The energy giant hadn’t reduced the yearly dividend since the mid-1940s.
Combating this sort of volatility is essential, and especially if you’re using dividend income to live on. The best way to do this is to create a diversified portfolio — the ‘sweet spot,’ according to many investors and market experts, is one that holds 15 to 20 different shares.
This might be enough to deliver a robust second income in all conditions. But it’s worth remembering almost 500 UK companies cut or delayed or axed dividends during the pandemic, affecting millions of investors relying on dividends.
Here’s the strategy
So how can investors better protect themselves from dividend disappointment? One strategy I use myself is to buy diversified investment trusts and exchange-traded funds (ETFs).
These products often hold a basket of securities covering different asset classes, industries, and regions, allowing investors to spread risk cheaply and quickly. And many of these are designed with passive income in mind, like the Aberdeen Equity Income Trust (LSE: AEI).
This closed-end investment company holds shares in 57 companies, including dividend heavyweights like Legal & General, HSBC, and BP. Roughly 97% of the trust is invested in UK-listed shares, which creates more regional stock market risk for investors. But many of its constituents operate across the globe, protecting earnings and giving it dividend strength.
Indeed, the trust has raised annual dividends for 25 years on the spin, making it one of London’s true dividend kings. Another predicted payout hike in 2026 leaves it with a large 6% dividend yield.
A £10k passive income
With a mixed portfolio of shares, investment trusts, and ETFs, I think a 7% yield is an achievable target. At this rate, a £20,000 Stocks and Shares ISA would deliver a £1,400 passive income in one year.
If an investor can keep this going, and puts £20,000 in their ISA each year with a 9% return, they’d have a £1.7m portfolio after 25 years. They would then earn £120,600 a year in dividends, or £10,050 a month.
