The Stocks & Shares ISA is an excellent vehicle for generating passive income. That’s because we pay no income tax on the interest or dividends received from investments within the ISA wrapper.
So, we’d all love to earn a substantial income from our ISA right? I certainly would. But is it possible to generate as much as £500 a month from an initial investment of £10,000?
I believe so! Let’s take a closer look.
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Generating income
Let’s tackle the first part. How do we generate income from an investment portfolio?
We can do this by investing in dividend-paying stocks and then, instead of reinvesting these dividends as we would as part of a compound returns strategy, we could withdraw them as income.
So, if I put £10,000 in an ISA this year, realistically, I think I could achieve £800 as a dividend return. That would involve me investing in companies that collectively give me an 8% yield.
For me, 8% is the very top end of what I could earn from sustainable dividends. But this wouldn’t be an overly diverse portfolio. This is because the biggest yields tend to come from a certain sectors, such as insurance, housebuilding, mining, and tobacco.
A portfolio based on these stocks doesn’t offer much in the way of exposure to growth, consumer goods, banks etc.
Compounding
Unfortunately, £800 a year isn’t going to change much. But if I invest my £10,000 for a number of years, while practicing a compound returns strategy, I can achieve a much bigger pot.
A compound returns strategy involves reinvesting my dividends and earning interest on my interest. It’s very much like a snowball effect. And if I continue contributing, I can increase the pace of growth substantially.
To earn £500 a month in passive income, I’m going to need at least £75,000 invested.
But the amazing thing about a compound returns strategy is that I’d only need 7.5 years to turn £10,000 into £75,000. That’s using stocks with 8% yields, and contributing £200 a month, while increasing that contribution by 5% a year.
It’s by no means a perfect science, and I could lose money. But I believe it’s the safest way to grow my portfolio.
The stocks for the job
As I mentioned, the majority of UK stocks offering big yields tend to be companies from certain sectors. That means a high-yield portfolio is unlikely to be hugely diverse. But it’s not too problematic as I can still spread my investment across three sectors, at least.
Some of the my top high income picks are in the insurance sector such as Phoenix Group, Legal & General, and Aviva. These stocks have an 9.1%, 8.5%, and 7.5% yield, respectively.
But there’s also a host of housebuilders with strong yields. Vistry Group doesn’t offer the best yield in the sector — 7.4% — but it could be one of the safest. Its income is boosted by the security of its affordable housing division.
Personally, I don’t invest in tobacco, but mining stocks, which are highly cyclical, offer great yields too.
