One of the reasons I invest money in a Stocks and Shares ISA is because of the income potential this offers me. I can put money into my ISA, buy shares and then benefit from any dividends the companies pay.
Doing this could turn out to be fairly lucrative – if I make the right choices.
Here is how I would use a £20,000 ISA to try and target close to £2,000 in dividend income annually.
Yield matters
The two factors that determine how much I might earn in income from owning shares are the amount I invest and my average dividend yield.
With £20,000 as a fixed number in my example, the factor that will impact my expected earnings is the average yield I generate.
To get £2,000 in income from my Stocks and Shares ISA each year, I would need to build a portfolio yielding 10% on average to hit my target. Of course, a risk is that I don’t achieve this if my chosen stocks underperform. But I could still achieve my income goal by adding more cash and stocks to my ISA.
Keeping to that £20k ISA plan though, one important risk management strategy is diversification. Owning a range of shares means that not all of them need to yield 10% for me to hit my target as long as some of them do.
Avoiding value traps
As an investor, I do not buy shares just because they offer a high yield as very high yields are not reliable. At different points last year, for example, Persimmon and Ferrexpo both offered yields much higher than 10%. Yet Persimmon cut its dividend and Ferrexpo has stopped paying out altogether.
Instead, I focus on finding great businesses with attractive share prices.
If I can avoid yield traps, I think a percentage dividend yield in the high single digits or low double digits is feasible. Currently in my portfolio, examples I own include British American Tobacco and M&G.
Other shares I have been eyeing for my Stocks and Shares ISA lately also offer me a similar yield. For example, the Income & Growth venture capital trust yields just under 11% at the moment.
Patient investing
But another important element to my approach is being willing to wait before buying a stock. That fits with my long-term investing strategy.
The reason that can help is because the lower a price I pay for a share, the higher its dividend yield would be (if the dividend is maintained). For example, I think Legal & General is an attractive business and would happily add it to my Stocks and Shares ISA if I had spare money to invest. Buying it today would offer me a yield of 8.5%.
But Legal & General shares are 13% more expensive now than at their lowest point over the past 12 months. If I had bought back then, I would now be earning a yield higher than 8.5%.
If I am patient and wait for real bargains, that could help me hit my dividend target.
To do that, though, I first need to identify some great businesses in which I want to invest. Then I will be ready to add them to my Stocks and Shares ISA once their prices hit an attractive level.
The post How I’d target nearly £2K of passive income annually from a £20K Stocks & Shares ISA appeared first on The Motley Fool UK.
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C Ruane has positions in British American Tobacco P.l.c., M&g Plc, and Persimmon Plc. The Motley Fool UK has recommended British American Tobacco P.l.c. 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.