Some people use a Stocks and Shares ISA to try and build long-term wealth from companies growing their business. For others, the ISA is a passive income vehicle.
By stuffing it with dividend shares, they hope to be able to sit back and watch the money roll in, without having to work for it.
Here, I want to focus on that second approach and explain more about how an ISA can be used to generate income.
Dividend shares can be lucrative
Not all shares pay dividends, even if they have done in the past. But a lot do. In many cases, well-established, successful and profitable businesses produce more spare cash than they need in their business and so pay it out to shareholders, sometimes offering regular dividends for decades on end. So owning the right dividend shares can be rewarding.
A couple of things strike me as important when trying to earn money from dividends. One is how sustainable a company’s payout looks. Getting to grips with its business model, free cash flows and outlook can be instructive, so it pays to stick to what you understand and can assess.
Another important factor is not overpaying for shares. With the focus on dividends, some people ignore share price. Over the long term though, share price movements also contribute to an investor’s total return from their ISA.
Come to that so do costs and charges, so it makes sense to pick thoughtfully when choosing a Stocks and Shares ISA.
Getting to grips with yield
A key factor here is what is known as dividend yield. That is basically how much you expect to earn in dividends annually, expressed as a percentage of the shares’ purchase cost.
High yields mean higher returns – but as dividends are never guaranteed, the question is always how sustainable those yields are. Some high yields last, others do not – but the same is also true of lower yields.
To target £500 a month of passive income (£6k a year), at a 3% yield like the FTSE 100 currently offers would take a £200k ISA. At 5%, it would only need £120k. If someone could earn a 7% yield, that would fall to £86k.
With less money the same approach could still work just fine – but the income would be proportionately smaller.
One 5.9%-yielding share to consider
Looking beyond the FTSE 100 to the FTSE 250, one income share I think merits consideration at the moment is DIY retailer Wickes (LSE: WIX). Currently, it yields 5.9%.
Over the past five years, the Wickes share price has fallen 24%. That means it now sells for only 11 times earnings. I see that as an attractive price, given its large customer base, well-known brand and proven business model.
When the economy slows, DIY sales can suffer. Some households will spend money to spruce up where they are, but a weaker property market can mean less big-ticket projects from people moving into a new home.
I see that as a risk for Wickes. In the first 17 weeks of the year, its retail business saw like-for-like revenue decline 2% year on year.
Fortunately, that was more than offset by growth in its trade division. Indeed, this mix of retail and trade business is something I like about Wickes’ business model.
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Christopher Ruane does not hold any positions in the companies mentioned.
