A Stocks and Shares ISA can give me a platform for buying into companies that hopefully grow in value over time. Along the way though, it can also potentially be a source of passive income in the form of dividends.
If I had £20K in an ISA and wanted to target a 7% yield – equivalent to £1,400 each year, or almost £27 per week on average – here is how I would go about it.
Chasing yield alone is a fool’s errand
Perhaps surprisingly, I would not start by thinking about the 7% figure. Why?
Dividends are never guaranteed, no matter how much a company may have paid out before. So a share that yields 7% today can yield 0% tomorrow.
At the start of last year, Direct Line yielded around twice that much before axeing its dividend altogether. It has since come back, but at a much lower level.
So, to try and avoid falling into a value trap, I would look for companies that I think have a strong enough business and clean enough balance sheet to sustain a chunky shareholder payout over the long term.
Some characteristics of a good dividend share
As an example, I would point to Legal & General (LSE: LGEN).
It ticks a lot of the boxes I look for when it comes to buying dividend shares for my ISA. I do not own it, but would be happy to buy it if I had spare money to invest.
For a start, there is the target market. It is large, resilient and deep-pocketed. People spend a lot of money on retirement-linked financial services, often over the course of decades. Then there are the competitive advantages enjoyed by the firm. It has a familiar brand, long experience and large customer base.
That has helped make it consistently profitable in recent years. It plans to raised its dividend by 5% this year and 2% annually in the years after that. So the current 8.7% dividend yield could be set to become even juicier.
Even Legal & General has cut the payout before though. The 2008 financial crisis led to that and I see a risk that any sudden market downturn could hurt profits badly and see another cut.
As a long-term investor, though, I think the future for the firm looks promising.
Constructing a high-quality blue-chip portfolio
Owning a share like Legal & General ought to earn me more than my target dividend yield.
So I could hopefully still hit my target even if some of the shares I bought yielded less than 7%.
Right now in the FTSE 100 there are plenty of blue-chip shares earning 7% or higher besides Legal & General. From HSBC to M&G and Phoenix to Imperial Brands, quite a few firms offer such high yields.
Sticking to the share selection principles outlined above, I believe I could choose the right ones for my ISA and realistically aim for £1,400 in annual dividends.
The post Here’s how to invest £20K in an ISA to target a 7% dividend yield appeared first on The Motley Fool UK.
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HSBC Holdings is an advertising partner of The Ascent, a Motley Fool company. C Ruane has positions in M&g Plc. The Motley Fool UK has recommended HSBC Holdings, Imperial Brands Plc, and M&g Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.