Is it worth waiting for better rewards down the line? That is a question I sometimes ask myself when considering what to do with my Stocks and Shares ISA.
By reinvesting dividends, I miss out on their short-term financial benefits.
But by reinvesting them, it helps grow the size of my ISA and so potentially setting me up for bigger passive income streams from dividends down the line.
Delayed gratification of a 9.8% yield!
To illustrate, let me use an example. Say someone has a £10k Stocks and Shares ISA and invests that in a diversified portfolio earning an average 7% dividend yield. That would earn them £700 a year of passive income.
But what if they did not take the dividends as passive income and instead reinvested (compounded) them?
Doing that, after five years the ISA ought to be worth over £14k. That should be big enough for a 7% yield to generate around £982 a year in passive income.
Setting a realistic target
Is a 7% yield achievable while managing risk? After all, high-yield shares can be a red flag that the City sees as potentially hard or impossible to sustain over the long run. Then again, no dividend is ever guaranteed to last – not even a small one.
But I think it can be achievable. In the FTSE 100, shares such as Legal & General (LSE: LGEN) and Standard Life yield 7% or greater.
Others are close to 7%, so could potentially form part of a portfolio achieving that yield on average overall. Examples include 6.6%-yielding Londonmetric Property and M&G.
But there is life outside the FTSE 100 and the FTSE 250 offering a host of shares that yield over 7% — well over in some cases.
Worth considering
As it happens, I do think Legal & General merits consideration for its long-term passive income potential.
The business often seems to be unloved by investors. The Legal & General share price has actually fallen by 5% over the past five years, a period when the wider FTSE 100 index has gained 48% in value.
But while the market may not seem that excited about the share, the dividends keep rolling.
There was one year during the pandemic when Legal & General held its dividend steady. Apart from that, it has grown the payout per share every year since making a big cut during the financial crisis.
The company aims to keep doing so despite already having the highest yield in the FTSE 100.
It has a strong brand and large customer base combined with a proven business model, meaning Legal & General is a cash generation machine.
That is good for the dividend, but one risk I see is the sale of a significant US business this year reducing recurring earnings, even though in the short term it provides a cash boost.
Still, taking the long-term view, I continue to like the passive income potential offered by Legal & General.
Should you invest £5,000 in Legal & General Group Plc right now?
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Christopher Ruane has no position in any of the shares mentioned
