Using a Stocks and Shares ISA, investors can choose growth shares they hope will help them ride the AI boom.
But an alternative use of an ISA could be to invest in businesses that over decades have proven they can generate more cash than their business needs. Paying that out as dividends can mean that shareholders earn passive income.
For example, say someone wanted to target a weekly annual passive income of £500. Here is how they could try to do so using a Stocks and Shares ISA.
Yield and total amount invested are key numbers here
That adds up to £26k a year. How big the ISA needs to be to generate that depends on its average dividend yield.
At 10%, for example, it would take £260k. But 10% is over triple the current FTSE 100 yield. It may be possible (though difficult) for investors with a high risk appetite, but I am not one of them.
I do think that a 7% target yield in the current market is realistic. That would require a Stocks and Shares ISA worth around £371k. Clearly, this is no overnight project but a long-term one. I think that is fair given the sizeable benefits it could ultimately offer in terms of passive income streams.
Putting in the £20k ISA contribution allowance annually and reinvesting it initially (known as compounding) rather than pulling out dividends, it would take 13 years for the ISA to reach the target size of £371k.
At that point, a 7% yield would equate to an average of over £500 a week in dividends.
How you invest matters
Of course, just putting the money in is not the whole story. Hitting that 7% compound annual growth rate and, later, 7% dividend yield is not guaranteed.
For starters, fees can add up. That is why it makes sense to choose carefully when deciding what Stocks and Shares ISA to use.
Dividends are never guaranteed. Even if a company has paid generous ones in the past, it can decide to stop. Also, share price falls could hurt the compound annual gain even with beefy dividends in the mix.
Clearly, the savvy investor will take some time to hunt for high-quality shares that can form part of a properly diversified ISA.
A share to consider
One income share I think merits consideration is 7.2%-yielding Standard Life (LSE: SDLF). The FTSE 100 financial services firm focuses on retirement-linked savings and pensions. It is huge – in fact, a fifth of British adults are customers. That gives the company significant economies of scale.
Retirement products are long-term investment vehicles so if performance and fees seem decent, most customers will stick with a supplier for years or even decades rather than frequently going to the hassle of switching to a new one.
So Standard Life has some significant advantages. It helps it generate sizeable cash flows that in turn fund the dividend. The dividend is already attractive – and Standard Life aims to keep growing its payout per share annually.
One concern is weak property market confidence. With its large mortgage book, that could potentially lead Standard Life to write down some assets’ value. Over the long term though, I see it as a share to consider.
Should you invest £5,000 in Standard Life right now?
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Christopher Ruane does not hold any positions in the companies mentioned.
