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With a new tax year upon us, a completely new ISA allowance begins once again.
I believe investing a stocks and shares ISA the right way can help turn it into a powerful long-term passive income machine.
Please note that tax treatment depends on each client's individual circumstances and may be subject to change in the future. The content of this article is provided for informational purposes only. It is not intended to be, nor does it constitute, any type of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.
If I wanted to target a second income of £13,900 a year, for example, these are the investment principles I would use when putting my £20,000 ISA allowance to work.
Take a long-term approach
Earning £13,900 of income next year from £20,000 would require me to earn a dividend yield of almost 70%.
I don't see it as remotely realistic. That is However, it is more realistic to increase the dividend yield I earn on an initial investment of £20,000 over time by compounding the dividends.
As an example, if I earned an average dividend yield of 7.5% on my ISA and compounded over 31 years, then I would be earning over £13,900 as a second annual income.
More than three decades is a long time to wait. On the other hand, I think the potential financial rewards justify it.
Stick to likely strong income producers
Past performance is not a guide to what will happen in the future. Dividends come and go.
So when building the portfolio for my ISA, I would look to the future and try to find companies that I think have the potential to provide long-term income streams.
To illustrate what I would do search, consider as an example Phoenix (LSE: PHNX). He FTSE 100 The company operates in a market that is likely to experience large and resilient long-term demand for providing financial services such as pensions.
It benefits from competitive advantages including strong brands, a large, entrenched customer base and deep knowledge of niche markets. It also has a proven ability to generate substantial amounts of cash.
Recently, the company said it plans to continue increasing the dividend annually. The yield is already a juicy 10.3%. However, keep in mind that you wouldn't buy a company based on its performance alone. First it must seem like a great deal to me that is sold at an attractive price. Only then do I consider its performance.
Spreading my options
Phoenix faces risks. For example, you have incurred higher than normal non-operating costs. He expects these to decrease once he completes a business growth investment program. However, if that does not happen, such costs could continue to affect profitability.
I'd like to reduce the risk of a single bad choice sinking my long-term income plan. I would therefore diversify into a range of different stocks in my ISA. £20,000 is enough for that.
Starting
In theory, I think it is now possible to earn £13,900 annually in the future with a £20,000 investment.
But in practice it is necessary to act. So now I would take the time to find the best stocks and shares ISA that I could then use as the basis of my second long-term income plan.
