Ever wondered how to turn a Stocks and Shares ISA into a passive income machine, without waiting years for dividends to compound?
Being a good investor
There are no guarantees, of course. But to start with, some basic best practices of investing apply. For example, diversification is key – basically, not putting all your eggs in one basket.
Spreading a £20k ISA evenly across five different shares would mean £4k in each.
Good investing principles also include sticking to what you know and making sure a portfolio carries a level of risk that suits your personal tolerance. Different investors may have different risk tolerance.
Putting theory into practice
Let me flesh that out by illustrating with a portfolio of five income shares I think are worth considering.
Their average current yield of 6.4% means around £1,288 of passive income a year from a £20K ISA. Dividends are never guaranteed though — they can go up, or down.
To start with, a FTSE 100 share that has grown its dividend per share annually for decades: British American Tobacco (LSE: BATS).
Underpinning that incredible track record – and the firm’s aspiration to keep increasing its dividend per share annually – is the proven ability to generate billions of pounds in free cash flow annually.
Cigarettes are cheap to make but can be sold for a pretty penny. British American’s portfolio of premium brands such as Pall Mall gives it pricing power.
Still, revenues are in decline. Even pricing power cannot make up for falls in sales volumes as cigarette demand declines.
Perhaps non-cigarette products like vapes will help arrest those falling revenues and keep the dividend growing.
Not all investors can accept the ethics of tobacco shares. For those who can, I see this 4.9%-yielding one as worth considering.
Making money from financial services shares
I also think two FTSE 100 financial services shares merit further research: M&G and Standard Life, yielding 6.6% and 7.2%, respectively.
They each have a different focus. M&G is an asset manager with millions of customers. Standard Life has a client base in the millions, but its focus is on retirement-linked savings and pensions.
Stock market volatility could lead policyholders to pull more out of M&G funds than they put in, hurting profits.
The share price is close to a record high, but a febrile UK property market could elevate the risk that its mortgage book may need to be written down in value if the property market tumbles.
Still, as a long-term investor, I like the prospects for both firms. They have large customer bases and proven cash generation potential.
Looking at the broader market
Many investors do not select all their own shares, preferring to buy into funds or investment trusts.
One I think merits consideration is City of London Investment Trust.
Its portfolio of blue-chip UK shares means a weak British economy could weigh on its performance.
But it also helps the trust do well when FTSE 100 shares perform strongly. The share is up 40% in five years and yields 4%.
Further afield, I also see 9.5%-yielding Henderson Far East Income as worth considering.
If higher oil prices hurt output in Asian economies, that could be bad news for the fund’s performance. But I like its geographic spread and high yield.
Christopher Ruane does not hold any positions in the companies mentioned.
