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A stocks and Shares ISA is a brilliant way to invest in UK companies to create a high and growing passive income stream for my retirement.
I think it is possible to achieve a 7% return from FTSE 100 Index shares, without taking excessive risks. If I were to reach the maximum of £20,000 that I am entitled to in my ISA, that would give me an income of £1,400 a year. Here is how I intend to achieve that goal.
The first thing to say is that dividends are never guaranteed. Companies have to generate enough cash to pay them, year after year.
The dream of passive income
On the other hand, if I choose the right company, I can expect to earn a second income that grows over time, as the company's directors reward loyal investors by steadily increasing payouts to shareholders.
I wouldn't just go for the highest FTSE 100 return. I'd also like it to be sustainable. Telecoms giant Vodafone Group It currently has a trailing yield of 10.27%. But that's misleading, because the dividend will be cut in half starting next March.
So I would focus on companies with a tidy balance sheet, stable profits and enough loyal customers to generate revenue over the long term.
HSBC Shares (LSE:HSBA) is a case in point. It has been making a killing lately, with full-year 2023 profits up 78% to $30.3 billion. Better still, the board is keen for shareholders to benefit from its success. It paid a dividend of 60 cents per share in 2023, the highest since just before the financial crisis in 2008.
As if that wasn't enough, it also granted them share buybacks totaling $7 billion. That was followed by another $5 billion in the first half of 2024. And there's still more to come.
HSBC is a FTSE 100 hero
Today, HSBC shares have a trailing yield of exactly 7%. To me, that's exactly what you're looking for. Better still, payouts are comfortably covered at 1.9 times earnings.
In fact, the yield is forecast to reach a whopping 9.4% over the next year, covered 1.6 times by earnings. That seems good enough to me.
Despite that, HSBC shares look cheap, trading at 7.6 times earnings. However, no stock is without risk. HSBC is heavily concentrated in Asia and could be affected if the Chinese economy continues to struggle.
If trade wars between China and the West worsen or turn into another kind of war, HSBC could be forced to choose sides. I would offset risks like these by investing in a spread of a dozen stocks over time. I would also try to hold them for a minimum of five to ten years, and ideally longer, to ride out short-term volatility.
Right now, I can see plenty of UK blue chip companies with similarly high yields, including insurers. Legal and General Group (9.07%), asset manager M&G (9.14%), and British American Tobacco (8.13%).
If I invest my money in shares like these, I think I can hit or even beat my 7% return target. If I reinvest every penny, I'll hopefully get over £1,400 in income in the second year, and even more the following year. It could potentially keep growing until I'm ready to take it in retirement.
