A Stocks and Shares ISA is an excellent vehicle for building wealth and for generating passive income. So, here’s how I’d invest £20,000 within an ISA wrapper while targeting a yield in excess of 7%.
A dividend yield indicates the proportion of a company’s value that’s returned to shareholders each year. For example, if I owned £1,000 of a stock, and it paid a 5% dividend yield, I’d receive £50 every year. And if I were to do this within a Stocks and Shares ISA, the money I receive would be tax-free.
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.
Passive income stocks: our picks
Do you like the idea of dividend income?
The prospect of investing in a company just once, then sitting back and watching as it potentially pays a dividend out over and over?
If you’re excited by the thought of regular passive income payments, as well as the potential for significant growth on your initial investment…
Then we think you’ll want to see this report inside Motley Fool Share Advisor — ‘5 Essential Stocks For Passive Income Seekers’.
What’s more, today we’re giving away one of these stock picks, absolutely free!
The benefits
Investors often like dividend-paying stocks because they typically offer several benefits. Firstly, the dividend can be taken as a passive income. It can also be reinvested, which generates a compounding effect.
Dividend-paying stocks can also be less volatile than non-dividend paying peers. And well-run companies typically increase their dividends annually.
And remember, the yield is always reflective of the price I pay for a stock. In 10 years time, a £1,000 investment in a 5%-yielding stock today could be worth £100 a year if the dividend payments double.
In fact, look at billionaire investor Warren Buffett’s first investment in Coca-Cola in 1988. After 35 years of dividend increases the yield on his original cost basis is nearly 57%.
10 juicy dividend stocks
So let’s start by highlighting some of the juiciest dividend stocks around the world right now.
| Stock | Dividend yield |
| Vodafone Group | 11.4% |
| Sociedad Quimica Y Minera De Chile | 11.2% |
| Phoenix Group | 9.9% |
| British American Tobacco | 9.8% |
| M&G | 8.4% |
| Crest Nicholson | 8.1% |
| Legal & General | 7.8% |
| Rio Tinto | 7.5% |
| Aviva | 7.3% |
| Imperial Brands | 7.3% |
It’s not all about big payouts
Obviously, many dividend stocks are highly attractive investment opportunities. However, it’s important we don’t put all our eggs in one basket and reduce our pool of possible investments. A strong and diverse portfolio may include a handful of dividend stocks, a handful of growth-focused stocks, in addition to assets like ETFs and bonds.
Of course, if we’re aiming to earn a passive income from our investments, we may want to be more focused on dividend stocks. If so, we still need to favour diversification, looking at multiple dividend stocks in multiple sectors.
Remember the coverage ratio
There’s more to dividends than just its yield. We’ve got to know whether the dividend is sustainable. And one of the best ways to do that is to look at the dividend coverage ratio.
This tells us how many times a company can pay dividends from its net income. A ratio below two is typically considered less safe, but there are other factors that come into this.
Cash flow is one. Companies with stable cash flows can be in a better position to pay dividends than their peers where cash flows might be more sporadic.
Take insurance, where policyholders pay monthly premiums, versus pharma companies where drug development can take decades and only after regulatory approval will they earn an income.
The bottom line
While I should be wary of big yields, and putting all my eggs in one basket, by taking a strategic approach, I can achieve a dividend yield in excess of 7% annually.
