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Money stuffed in the mattress or earning no interest is eroding in real terms, due to the corrosive effect of inflation. That is why many investors try to put it to work in a Stocks and Shares ISA.
Doing that can have tax advantages. Depending on someone’s financial situation, they may be able to draw any income such as dividends from their Stocks and Shares ISA tax-free.
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.
Can such an approach be lucrative? With careful selection of what shares to buy and a long-term approach to investing, it potentially can be.
For example, if an investor compounds a £20k Stocks and Shares ISA at 8% annually for 20 years, it will be worth over £93k. At an 8% dividend yield, that ought to generate monthly passive income averaging £621. That said, to avoid eating into the size of the lump sum, it might be best not to take the full percentage.
Building long-term returns
When I talked about an average compound annual growth rate of 8%, there are two key elements to understand.
One is dividends. They are not guaranteed, but can be substantial. While the blue-chip FTSE 100 index average yield currently stands at 3.3%, a markedly higher yield is achievable in today’s market while still sticking to blue-chip shares.
Share price gains can also contribute to compound growth, although conversely falling share prices could eat into it.
One other factor that some investors overlook is the impact of seemingly small fees and costs. Over time these can add up, so it makes sense to spend some time comparing the wide range of Stocks and Shares ISAs on the market.
One share to consider
Let me bring this to life using a real-world example.
One share I think investors should consider is FTSE 100 financial services powerhouse Legal & General (LSE: LGEN). Not only does it already offer a dividend yield of 8.3%, it also aims to grow its payout per share by 2% annually.
That is more modest than it managed of late. Along with weaker earnings in recent years, I think that explains the long-term underperformance of the Legal & General share price. Sure, it has grown 19% over the past five years – but that was well below the 48% growth in that period of the wider FTSE 100 index.
But I see continued reasons to like Legal & General. It has a proven business model focused on the resilient market of retirement-linked investments. Its strong brand, large customer base and extensive investing experience all help set it apart from rivals.
The sale of a large US business could also help boost funds, although in the longer term I see a risk that it may mean lower profits for the firm.
Generating income isn’t rocket science
Put like that, such an approach to trying to turn a Stocks and Shares ISA into a passive income machine does not sound complicated.
It does not need to be. There are points to watch for, of course, from carefully selecting the shares one buys to spreading risk by diversifying the ISA. And a £20k starting point is ample to do that.
With prudence and patience, I think an ISA really can be used to try and produce substantial passive income streams.
