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I see a stocks and Shares ISA as a long-term investment vehicle. Along the way, if I can generate passive income in the form of dividends, even better!
In fact, I believe an ISA can be a lucrative dividend generator. At £20,000, this is how I would aim for £5,000 a year.
Establish a schedule and focus
If you wanted £20k to earn £5k in dividends each year right away, you would need to earn an average dividend yield of 25%. No FTSE 100 the stock pays something close to that amount.
However, there is another approach. You could invest in stocks with a lower yield and then reinvest the dividends to buy more shares. This is known as capitalization.
If I built up a £20k stocks and shares ISA at 7% a year, after 19 years it should be worth more than £72,000. With a 7% dividend yield, that would be big enough to allow me to reach my target of annual dividend of £5,000.
What I would be looking for
Is that possible? I think it is. In today's market, several blue-chip stocks are yielding 7% or more. My focus would be on buying quality companies with proven business models that I believe had strong future revenue prospects.
However, instead of putting all my eggs in one basket, I would diversify into several stocks. I wouldn't just look at stocks that are currently performing attractively. After all, no dividend is ever guaranteed to last.
Instead, I would look for companies that, in my opinion, were likely to have a strong source of future income.
A stock I bought for income in 2024
As an example, consider a stock I bought this year and still hold: Legal and general (LSE: LGEN).
It benefits from continued strong demand for financial products linked to retirement. Thanks to its strong brand and long experience in the financial markets, the company has created an important customer base. I see it as an advantage for the business and I also like its financial performance.
That has helped Legal & General refine a business model that has been consistently profitable in recent years. It has set plans to continue increasing its dividend annually (albeit by a smaller amount than currently). As said, while dividends are never guaranteed, if Legal & General sticks to its plan, the potential yield would be even higher than the 8.9% it offers today.
What are the chances of that happening? One risk I see is a market slowdown leading to clients withdrawing funds, which will reduce the profitability of the FTSE 100 company. Overall, however, Legal & General is exactly the type of stock I like to own from a passive income perspective. I plan to keep it long term.
