A Stocks and Shares ISA lets me buy into brilliant dividend-paying companies in the UK and beyond.
Depending on how much I put into such an ISA and the investment decisions I make, I think it could well be a passive income machine.
To illustrate, let’s imagine that I put £380 each month into my ISA.
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How to calculate dividend income streams
The amount of passive income I would earn depends on how much I invest and what average dividend yield I earn.
Yield is basically what I earn in dividends each year expressed as a percentage of what I paid for the shares.
Putting £380 a month into a Stocks and Shares ISA for a year would mean I had £4,560 to invest. At a yield of around 4% (slightly higher than the FTSE 100 average), that ought to earn me passive income of around £182 per year.
Three ways to boost my income
But that is only the start!
If I kept putting £380 a month into my ISA, I ought to earn more. I should still be earning any dividends declared from shares I had bought in previous years, as long as I held on to them.
I could also reinvest my dividends, instead of taking them as cash. That is known as compounding.
A third move would be to raise my average dividend yield.
To illustrate, imagine that I put £380 each month into my Stocks and Shares ISA at an average yield of 8% and compounded the dividends. At the end of the five-year period, I would be earning over £2,200 annually in passive income. That equals over £40 a week.
Focus on quality
Keeping up my regular contributions and compounding the dividends? I would definitely aim to do that if my finances allowed.
As for an 8% average yield though, things are less clear cut.
Dividends are never guaranteed. Sometimes a high dividend can signal an elevated risk of a cut. Vodafone yields 10.3% — but it has announced plans to halve the payout per share.
Still, I think an 8% average yield from blue-chip shares is possible in today’s market. But that would not be my starting point.
Instead, I would focus on companies I think have an edge in markets I expect to experience resilient customer demand – and that have an attractive share price.
One share I’m eyeing
An example I would consider buying for my Stocks and Shares ISA is Legal & General. The FTSE 100 financial services provider has a yield of 8.3%.
It is highly cash generative thanks to a well-known brand and large customer base helping it compete convincingly in the lucrative pensions market. We are all always getting older, so I expect pensions to remain big business far into the future.
Legal & General has cut its dividend before. That happened in 2008, as turbulent financial markets threatened its returns. The same could happen again if markets tumble and policyholders withdraw funds.
As a long-term investor though, I feel Legal & General is the sort of share that could help turn my Stocks and Shares ISA into a passive income machine.
