One way to earn some money each year without working for it is by buying a Stocks and Shares ISA and stuffing it full of high-quality dividend shares.
If I had a £20K ISA and wanted to target £1,600 in annual dividends, here is how I would go about it.
Using an ISA as an income machine
Dividends are never guaranteed but many blue-chip firms have proven business models and a strong commitment to paying dividends.
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So, if I choose the investments I make carefully, hopefully I could turn my Stocks and Shares ISA into an income machine.
I would be looking for great companies that could generate substantial ongoing free cash flow. To spread my risk, I would invest the £20K across five to 10 different shares.
To hit my target I would need to earn an average dividend yield of 8%.
I would not simply hunt yield, but rather would try to find great companies selling at attractive share prices. Only then would I consider the yield.
The good news, though, is that at the moment there are quite a few FTSE 100 companies I think have great income potential and currently yield around 8%, or higher.
What I’m looking for
As an example of the sort of company I am talking about, consider M&G (LSE: MNG).
The asset manager operates in a sector I think could benefit for a long time to come from high customer demand. It may go up and down. For example, when the economy is poor investors may pull out funds, but over the long run I expect it to be substantial. As the sums involved are large, it can be very lucrative.
M&G is not the only asset manager – far from it. So competitive pressure is a risk to profitability.
But M&G has attributes that I believe can help it prosper, such as a well-recognised brand and existing customer base spread over more than two dozen markets.
The shares yield 8.6%. If I had spare cash I would be happy to add them to my Stocks and Shares ISA.
FTSE 100 bargains
There are some other FTSE 100 companies that look like potential bargains to me when weighing their business potential against their current share prices.
But, as always, one needs to consider risks.
For example, I own Vodafone. I like its strong brand, large customer base, and exposure to fast-growing mobile money in its African markets.
Not only that, but right now Vodafone shares offer a mouth-watering yield of 10.9%.
That certainly grabs my attention. However, such high yields are often an indication of City concerns about the sustainability of a dividend. Vodafone has been shedding businesses over the past several years. That could lead to lower earnings in future and perhaps a dividend cut.
I still own the telecom business in my Stocks and Shares ISA. But taking risks seriously matters. So as an investor, I am hunting for the sweet spot where shares in great businesses can be bought for bargain prices!
