With the deadline for new contributions to one’s Stocks and Shares ISA, I have been thinking about how I might take advantage of it.
One approach would be to invest my ISA with the objective of generating substantial passive income in the form of dividends. As an example, if I wanted to target £1,600 in yearly passive income from a Stocks and Shares ISA with £20,000 cash in it, here is how I would go about it.
Target yield
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I think so. It would require me to earn an average dividend yield of 8%. That is high but it is not unrealistic in today’s market.
Quite a few blue-chip FTSE 100 shares currently have a yield of 8% or above, including Barratt, Legal & General, M&G, Phoenix, Taylor Wimpey, and Vodafone. On top of that, there are some investment trusts with 8%+ yields.
But just because a share pays a certain dividend now does not mean that it will continue doing so. So, when investing my Stocks and Shares ISA, I follow a couple of principles. I diversify across different shares. With £20,000, I could split the money evenly between five to 10 shares.
I also focus on buying shares in brilliant businesses at what I regard as an attractive valuation. That means that I do not just focus on yield. I hunt for quality at the right price and only then consider my dividend objectives.
Finding shares to buy
What makes a great business?
First I look for a company operating in an area I expect to keep experiencing high customer demand. Then I consider whether it has some competitive advantage that can set it apart from rivals in that field, such as patented technology or a strong brand. That helps give a firm pricing power and that can help it make profits.
I look for an attractive share price, even if my investment objective is dividend income not a share price increase. After all, despite being a long-term investor I may still want to sell the shares at some point in future. If I have generated a lot of dividend income from them but end up selling the shares at a heavy loss, the lifetime value of my Stocks and Shares ISA may end up being down overall.
At this point I also consider dividend yield. If I want to target £1,600 in annual income and a share’s yield is not high enough to help me do that, I may decide not to buy it for my income portfolio just yet. If the share price falls in future, the yield potential could rise to a level I find attractive.
Using my ISA allowance
Putting £20,000 into a Stocks and Shares ISA would use up my annual allowance. Once the money is in the ISA, I do not have to invest it immediately or indeed even soon.
Instead, I can and would take time to choose the sort of high-quality income shares I hope might generate large dividends for years or decades to come.
