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I am convinced that I know the best possibilities to generate passive income from long-term investments. I assume it has to be a stocks and Shares ISA.
It opens me up to more risk than a cash ISA as they offer guaranteed interest rates. Well, at least while the last contract lasts. But when the Bank of England (BoE) reduces inflation to its 2% target, I think we will be lucky to see Cash ISA rates well above 1%.
I don't see much point in trying to save the tax at that level of income, not when it's total FTSE 100 Returns have averaged about 6.9% annually over the long term. It's not guaranteed, of course, but the story is behind it.
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bad spells
To take home £10,000 a year from my ISA, I'd like to be able to not deplete my capital too much. If the Bank of England meets its inflation target, I would like to leave enough money in my ISA to match it.
That suggests it could take 4.9% of the 6.9% annual average and leave the other 2% to keep pace with rising prices. So how much might you need?
My sums suggest a pot of around £204,000. If the UK stock market continues to perform as it has for the last century, I should be able to take my £10,000 out of it and leave enough to keep pace with inflation.
What is the best way to take the cash? For me, that's where the dividends come in. Let's pick a FTSE 100 stock to use as an example.
bank dividends
I will go for Lloyds Banking Group (LSE: LLOY), because among my holdings it has the closest dividend to that target of 4.9% of income.
In fact, Lloyds currently has a forecast dividend yield of 5.4%, so it could even leave a bit behind to build up profits for next year and beyond.
But this brings me to my first serious need for caution. Dividends are never guaranteed and Lloyds is a good example of this. The bank had to suspend its dividend when the pandemic hit and the stock market crashed in 2020.
In fact, most of my dividends fell that year. So if I had earned passive income, I would have needed to sell some stocks to reach my goal.
Financial crisis
Looking back to the 2008 financial crisis, Lloyds suffered much more back then and it took some time to return to progressive dividends.
What is the way to minimize risks like that? In a word, diversification. I especially like investment trusts for that reason and have several. And I always try to hold a variety of stocks from different sectors.
Oh, and I'm basing these numbers on historical returns, which we may not get in the future. I think it's better to aim a little higher than to fall short.
For most of us, building a fund of £200,000 or more could take a few decades. Fortunately, I started investing in ISAs a long time ago. And I think my goals are realistic.
