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We’d all love to earn some monthly passive income to top up our pensions when we retire, wouldn’t we?
If it’s tax-free, even better. There’s no tax to pay on interest from a Cash ISA, for example. But as Bank of England rates fall, I expect we’ll soon be back down to interest of 1% or less. I’d rather pay tax on a better return than save the tax on such a pittance.
Fortunately, there’s a way we can aim for the best of both worlds, using a Stocks and Shares ISA.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Top returns
For more than a century, the UK stock market has beaten other forms of investment hands down. Over the past 20 years, total annual FTSE 100 returns have averaged 6.9%. That includes share price gains and dividends.
It’s been volatile though. In the 2019-2020 financial year, the average Stocks and Shares ISA made a 13.3% loss. And I thought it was going to be a lot worse, seeing how the early days of the pandemic were going.
Investing in shares really needs a long-term outlook. For investors who aren’t comfortable taking short-term losses, well, maybe they should stash their cash elsewhere. There’s nothing wrong with being cautious. Those of us who do go for shares can help reduce our risk by seeking diversification.
How much would we need in an ISA to make a 6.9% annual return worth £1,000 a month? I reckon it should take a pot of about £174,000. And if we wanted to take the cash only from dividends (of, say, 4% a year on average), we could need £300,000.
Dividends
I see four key parts to a strategy to achieve our passive income goals. Start early, invest as much as we can each year, keep going as long as we can, and reinvest all our dividends.
But what makes a good dividend? A high yield’s nice, but only if it can be sustained. I’d prefer a lower current yield, but based on a long track record of rises. Look at Murray Income Trust (LSE: MUT), for example.
It’s an investment trust that aims for a mix of rising dividend income and capital growth. It does it by investing in stocks such as RELX, AstraZeneca, National Grid, and a range of others. So there’s some diversification from just one buy.
Currently, the trust has a forecast dividend yield of 4.6%, I’d need around £261,000 to earn £1,000 a month passive income at that rate. More importantly, it’s raised its dividend for 51 years in a row.
Cover the risk
The 10-year share price performance hasn’t been brilliant, sadly. It does put the shares on a 12% discount to underlying assets, which might make them look good value — but it will reflect investor uncertainty.
Maybe the market’s put off by the trust being managed by abrdn, whose own share price performance has been poor?
There’s clearly risk here. But I do think investors with a long-term outlook who want to build passive income could do well to consider holding some investment trusts like this in their ISAs.
