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How I’d invest £10k in a Stocks and Shares ISA to generate a passive income

Life as a saver has been difficult over the last decade. Interest rates have been at or near historic lows during that time, while the income investing opportunities of mainstream assets such as bonds and buy-to-let investments have been relatively disappointing.

However, generating a passive income may be easier than many people realise. Opening a Stocks and Shares ISA to invest in FTSE 350 shares could be a shrewd move. It could offer a net income return that is two or even three times the rate of inflation, thereby providing a generous passive income over the long run.

FTSE 100 income opportunities

Perhaps the most obvious place to start when seeking to generate a passive income from a Stocks and Shares ISA is the FTSE 100. The index currently offers a dividend yield that is in excess of 4%, which is above its historic level. Since investments made in a Stocks and Shares ISA are exempt from tax, the net return on FTSE 100 stocks could be even more favourable when compared to other mainstream assets such as buy-to-let properties.

Furthermore, a wide range of large-cap shares offer dividend yields above the index’s average. It is possible to obtain a 5% or even 6% average yield from buying a mix of FTSE 100 shares. This could enable a £10k investment to produce an annual income of as much as £600. Obtaining a similar passive income from a Cash ISA at a 1.5% interest rate would require a £40k investment.

Dividend growth opportunities

As well as seeking out higher-yielding shares in the FTSE 100, buying companies that offer impressive dividend growth prospects could be a sound move. This may entail an investor focusing on companies with exposure to fast-growing markets, such as India and China, in order to enjoy a tailwind over the long run.

Furthermore, ensuring that a stock offers an affordable dividend could be highly important. After all, a high yield is not of much use if it is cut over the coming years. Therefore, ensuring that any stocks purchased have modest dividend payout ratios, sensible levels of debt and encouraging cash flow could prove to be a prudent step to take. In addition, purchasing shares in companies that offer defensive characteristics may be worthwhile at a time when the outlook for the UK and world economies are somewhat uncertain.

Diversify

While it may be tempting to buy a limited number of stocks that offer the highest yields, purchasing a diverse range of businesses could significantly reduce overall risk. It may mean that your passive income proves to be more robust and reliable over the long run, thereby providing less worry about its prospects.

Moreover, having a diverse portfolio of stocks could enable you to benefit from the variety of opportunities present in different sectors and regions in order to maximise your passive income in the long run.

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Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.