Using a Stocks and Shares ISA to buy dividend shares is a common way for people to set up passive income streams.
It can also be very lucrative.
For example, a £20,000 ISA could generate a four-figure monthly passive income while sticking to blue-chip FTSE 100 shares. Here’s how.
Should you invest £1,000 in Speedy Hire Plc right now?
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Setting up for success
Let’s start with the basics.
One’s getting the right ISA. Fees and costs can eat into passive income streams. So it pays for an investor to choose carefully when deciding what Stocks and Shares ISA best suits their needs.
Next is the simple arithmetic question of what sort of investment could generate a monthly passive income of £1,000.
That’s £12,000 a year. From a £20,000 investment that suggests a 60% dividend yield, which I see as totally unrealistic.
By reinvesting dividends each year over the long run, though – something known as compounding – I do think the goal is achievable. For example, imagine an investor manages an average yield of 7%. After 32 years, their ISA ought to be generating over £1,000 of passive income each month.
Sure, 32 years is a while. But this is a long-term investing approach, which I think is understandable given the ambitious nature of the passive income goal.
Finding shares to buy
Still, the theory’s all well and good – but is a 7% dividend yield realistic while sticking to high-quality blue-chip companies? After all, it’s around double the average FTSE 100 yield right now.
I think that it’s achievable in today’s market, but as always it’s important that an investor doesn’t only focus on yield. No dividend is guaranteed to last. So I think the important thing is always to look first for brilliant businesses with attractive share prices and only later to zoom in on what their yield is.
An example of one such share I think investors should consider is M&G (LSE: MNG). The FTSE 100 asset manager recently grew its annual dividend per share, in line with its policy of aiming to maintain or grow the payout every year.
With a 9.9% yield, that has made M&G even more lucrative for shareholders. The market for asset management is huge and likely to stay that way in my view.
M&G’s strong brand combined with a customer base in the millions has proven a valuable formula when it comes to generating sizeable free cash flows that can help fund the dividend.
M&G’s cash generation potential is proven but one risk I see is that investors will pull out more funds than they put in. M&G has been struggling with that challenge over the past couple of years and I see it as a risk to future profits.
But I think there’s a lot to like about the company – and certainly the passive income potential of its chunky dividend yield.
