We’re now over two months into the current Stocks and Shares ISA year. Even though there’s a cap of £20k that can be invested annually, it’s still a great tool that can be used to generate substantial passive income over time. When looking at the numbers, here’s how someone could reach £740 a month.
Step by step
One advantage of using an ISA for this strategy is that the dividends received are tax-exempt. This means that the full amount of money is received and then can be used as cash flow to buy more stock. Over time, this can really compound.
I don’t see the £20k annual cap as much of a disadvantage, as for most of us it won’t be exceeded. Instead, it allows an investor to put to work a regular amount each month. To determine how much needs to be invested to hit the target, we need to estimate the portfolio’s yield.
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Based on buying FTSE 250 and FTSE 100 dividend stocks, I think it’s possible to target a 7% annual yield. Of course, a higher figure can be targeted, but I feel this increases the risk too much.
If we use the 7% figure to hit £740 monthly, the ISA would need to be worth £126,857. So if someone made full use of the £20k each year, this could be possible to reach in just a few years. However, let’s say someone invested £500 a month. In this scenario, it would take just over 13 years to achieve.
Of course, these are just projections. Depending on what happens to the stocks picked in the years to come, the target time could be longer or shorter than planned.
A strong dividend contender
After the figures, the next important step is to fill the ISA with sustainable dividend ideas. One example is OSB Group (LSE:OSB). The stock’s flat over the past year but boasts a dividend yield of 7.1%.
It’s a specialist lender focused on niches of the UK mortgage market that larger high-street banks often overlook, but makes money in a similar way. It gathers deposits from savers and then lends that money out at higher interest rates. The difference between what it earns on loans and what it pays on deposits is known as the net interest margin (NIM), and this remains the key driver of profitability.
As for the dividend, the company boasts a dividend cover ratio of 1.95. Any figure above 1 means the income is completely covered by the latest earnings per share and is a good sign. In fact, management recently lowered its long-term capital target, potentially freeing up more than £100m for shareholder returns, such as dividends. That also suggests the board sees excess capital generation continuing over the coming years
In terms of risks, CEO Andy Golding said in an April trading update that “we are mindful of the ongoing uncertain geopolitical situation and its impact on the UK economy”.
It’s true that the company is heavily exposed to the fate of the UK, and things are quite fragile as we stand.
Even with that, I think the stock could be a good one for investors to consider as part of building up a solid ISA.
Should you invest £5,000 in OSB Group right now?
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Jon Smith has no positions in the shares mentioned
