A Stocks and Shares ISA can provide a way to try and build wealth for the long term. But it can also be useful as a way to generate passive income streams thanks to dividends.
If I had £20K and wanted to target £1,600 in annual dividend income, here I show I would go about it using a Stocks and Shares ISA. (In fact, even if I had a lot less than that to invest, I could still follow these principles but with a more modest annual income target).
Defining the task
There are two ways I could aim to earn £1,600 in dividends annually from a £20K portfolio. One is to invest in a portfolio with an average yield of 8%.
The other would be to invest in a portfolio with a lower average yield, then compound the dividends until I hit my annual income goal. At a 5% average yield, for example, then after 10 years my portfolio ought to be earning me over £1,600 annually in dividends.
Finding shares to buy
Smart investors do not let the tail wag the dog.
Dividends are never guaranteed, so a high yield today can turn into zero yield tomorrow. That happened last year to shareholders in Direct Line, when the company abruptly cancelled its dividend. That is not an isolated incident.
So my focus would be on finding brilliant companies selling at attractive prices I could buy for my Stocks and Shares ISA.
Even then, the unexpected could happen, so I would diversify my ISA. With £20K, I could comfortably spread my money evenly over five to 10 different businesses.
What sort of business to buy into?
That may all sound well in theory but I will now try to illustrate with an actual share.
The financial services provider Legal & General (LSE: LGEN) is well known. It has shifted its business focus over the years and now mostly sells pension and retirement products. But decades of promotion using its iconic multi-coloured umbrella logo means that the company is firmly entrenched in the minds of lots of potential investors. It also benefits from a large customer base.
Pensions can be big business. Demand is high and I expect it to be resilient, though in a difficult economy some customers may use their money on other nearer-term needs. The big sums involved can add up to hefty fees and commissions for providers.
In its most recently reported year (2022), Legal & General earned £2.3bn after tax. Its dividend yield is currently 8.1%, almost exactly in line with the 8% target I mentioned above.
Buy brilliant shares and earn
The FTSE 100 firm has cut its dividend before, in the 2008 financial crisis. Another recession eating into demand could hurt profits. That is exactly the sort of reason I keep my Stocks and Shares ISA diversified.
But if I was to spread the £20K over a range of proven blue-chip companies I think are attractively priced, I see no reason to believe the £1,600 annual passive income target cannot be achieved.
