Buying passive income shares in an ISA is a proven way to build long-term wealth. With any dividends reinvested, portfolio growth can be sharply accelerated… leading to serious retirement wealth!
Turning £500 into £3,270 a month
We can invest up to £20,000 a year in a Stocks and Shares ISA. Investing as much as you can earlier on is better, as it gives your money more time to grow. But even drip-feeding money regularly throughout the tax year can create an enormous nest egg for retirement.
This is thanks to the exceptional wealth-building power of the stock market. Over recent decades, the average annual return has come in at 8%–10%. No other asset class has provided this sort of strong and reliable long-term return.
Let’s crunch some numbers to illustrate how this can build retirement wealth. We’ll use the example of a 40-year-old who has zero investments, and hopes to retire at age 65. Despite starting from scratch, he or she has a terrific chance of achieving a £3k+ monthly ISA income in retirement.
How? Well let’s say they can achieve a 9% average annual return, the midpoint of that 8% to 10% range I described. If they invested £500 a month, they’d have a portfolio of £560,561 by the time they retire.
This would then throw off a £39,239 passive income each year if invested in 7%-yielding dividend shares. That works out at £3,270 a month, although this isn’t guaranteed.
What should investors buy?
Of course 7% is a pretty high dividend yield. That’s above the FTSE 100‘s long-term average of 3% to 4%, and finding quality companies with a yield this size can be challenging. These are sometimes a by-product of falling share prices, signalling that something isn’t right at the business.
So what are some decent passive income shares to explore today? One FTSE-listed stock that’s on my personal radar right now is Standard Life (LSE:SDLF). The forward yield here is 8.1% and is no anomaly.
Dividend yields have risen every year for more than a decade. And since 2016, they’ve risen at an annual rate of 3.2%. This has left an average dividend yield of almost 8%.
However, past dividends aren’t always a reliable guide to future payouts. And Standard Life, as a financial services provider, faces severe headwinds as inflation rises and consumers cut back on discretionary items.
This might impact the company’s share price. But would dividends be hit? I think not. With more than 12m customers, it can expect its robust cash flows to continue, underpinning more large and growing dividends. Standard Life’s huge capital buffer also boosts its dividend prospects (the firm’s Solvency II ratio is a high 176%).
Passive income advice
Buying just one or two dividend shares for income is a high-risk strategy. While I’m optimistic this FTSE 100 company will remain a top passive income share, there’s always the risk of payout disappointment. Investors should consider building a diversified ISA for long-term resilience, and think seriously about adding Standard Life shares to it too.
