Sit back and let my ISA pile up passive income for me in the form of dividends? That sounds appealing – and is exactly what a lot of people do.
Many of them are not experienced investors who spend all day thinking about the markets, but simply ordinary people going about their daily lives who see an ISA as a useful vehicle to try and build a second income.
Free money – billions and billions of it!
Every year, Britain’s 100 biggest listed companies pay out tens of billions of pounds in dividends to shareholders.
That can change over time, as dividends are never guaranteed to last. But by sticking to a diversified range of large, proven businesses committed to shareholder payouts, I think an investor can feel reasonably comfortable that over the long term the dividend prospects look decent.
So simply by owning such shares, hopefully they can earn dividends without working for them.
As for how to do that, it is possible simply to use a share-dealing account or trading app and not bother with an ISA. Personally though, I like the fact that in a Stocks and Shares ISA, I can earn those dividends free of tax.
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Here’s what it takes to earn
The amount of passive income depends on several key variables – how large the ISA is and its average dividend yield. A £1k monthly passive income works out at £12k a year of dividends. At a 10% yield, that would take a £120k ISA.
At 5%, £240k. With a 1% yield, the ISA would need to be worth £1.2m.
Setting realistic expectations about earnings
What is realistic? While some tech shares yield well under 1%, the FTSE 100 average at the moment is 3.1%.
That average includes shares that pay no dividends like Burberry and ones that pay small dividends, such as Scottish Mortgage Investment Trust (though its yield is small, it has not cut its dividend per share for close to a century!).
So with careful selection, I think it is possible to build a diversified portfolio of say five to 10 FTSE 100 dividend shares and realistically target a yield of 6%. An ISA worth £200k would then earn an average of £1k a month in passive income.
Not got £200k – or even an ISA? It could be built up over time, possibly speeding things up by reinvesting dividends along the way.
Looking for long-term dividend performance
One share I think investors with an eye on building passive income streams ought to consider at the moment is Aviva (LSE: AV). The insurer already yields 6.4%. It has also been growing its dividend per share handily since a steep cut in 2020 and aims to keep doing so.
Aviva has some deep strengths, as I see it. It is the country’s biggest general insurer by some distance, giving it economies of scale and the opportunity to try and sell more products to existing customers.
A strategic focus on the UK market has grown in recent years, as it has trimmed its international operations.
That brings a risk though. Being the biggest player in one market makes Aviva susceptible to pricing competition from upstart rivals seeking to grow market share.
That could hurt profitability. Still, I see this proven operator as a share to consider.
