As a long-term investor, I aim to grow my Stocks and Shares ISA, over time. And many of the dividends I receive are reinvested to buy new shares. That way, I aim to boost my future returns with the magic of compounding.
But I also own some shares I use to earn regular passive income.
Top income stream
Dividends are an excellent way to create an additional income stream. Many companies distribute a share of their profits to shareholders in the form of quarterly cash payments.
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But some shares are more reliable than others. And as dividends aren’t guaranteed, I’d rather own stocks that offer the best possible chances.
That means looking at a company’s history. Some shares have been distributing dividends for not just several years, but decades. And the odd few also have a track record of raising their payments over time.
Promising profits
Of course, there’s no guarantee a business will continue making payouts. Dividends tend to be paid from earnings, so any fall in a company’s prospects could affect the amount paid out.
That’s why I prefer to own shares that offer a promising chance to grow profits.
But how many dividend shares would I need to earn £1,000 in passive income? To answer that, I’d need to know the average dividend yield I’d expect to achieve.
The FTSE 100 currently offers a dividend yield of around 3.6%. But I’d say some of the best Footsie income shares offer around 7%.
What I’d buy
With a 7% yield, I calculate I’d need to invest just £14,285 in my Stocks and Shares ISA to earn £1,000 a year in income.
If I had spare cash to allocate to this strategy, I’d split my investment between a few shares. But which should I consider?
First, I’d buy Legal & General Group. It’s an established and mature company that offers retirement solutions to companies and individuals.
With a recent dip in share price, it now offers a 7.7% yield. I’m frequently impressed by this share’s dividend history. It has consistently paid out for over 31 years.
Although, it’s not guaranteed it will continue to do so forever, it gives me confidence in its long-standing policy.
In addition, L&G sets out an ambition to grow the dividend over the coming years. That’s just what I like to hear when I’m looking to extract income from shares.
A defensive choice
Next, I’d buy shares in Imperial Brands. It currently yields 7.1%. One key element I like to see is how affordable a company’s dividend is. The measurement I use to determine this is dividend cover.
Imperial offers a cover of around 2x. That means it could theoretically double its payout and still have sufficient earnings.
This is a defensive business that offers an element of safety when global stock markets are tumbling. Bear in mind that it sits in an industry that is frequently hit with new regulations or taxes. That said, it continues to deliver steady profits.
