A Stocks and Shares ISA can be an excellent way to earn an additional income stream. I’d do so by owning a basket of quality dividend shares.
Dividend shares allow me to earn a slice of a company’s profits. And in addition to regular quarterly income, I could benefit further if the value of the business grows over time.
Cash vs Stocks and Shares ISA
With the jump in interest rates over the past year, it has made me question whether I should be earning income from a Cash ISA or a Stocks and Shares ISA.
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With some Cash ISA’s offering 5% a year, I’ve placed some money there. But the bulk of my investments remain in stocks. And here’s why.
Although the average dividend yield in the FTSE 100 is 3.8%, many stocks offer much more. For instance, 20% of this large-cap index offers more than 6% a year.
Several companies also manage to grow their dividends. Although annual increases might initially appear small, they can have a big impact over time.
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.
Buffett’s biggest holding
Globally, one of the best-known dividend growth stocks is Coca-Cola. The drinks giant has grown its dividend annually for a whopping 61 years.
This can have a remarkable effect on a shareholder’s investment. Consider its largest shareholder, Warren Buffett’s Berkshire Hathaway. It bought Coca-Cola shares over three decades ago at an average cost of $3.25 a share. At the time, its dividend yield would have been around 3%.
But as its dividends have grown significantly over that period, it currently pays out $1.84 per share. That means Buffett earns a whopping 56.6% yield based on the price he paid.
That’s why taking a long-term approach for a Stocks and Shares ISA can be particularly lucrative for earning passive income.
A word of warning
Bear in mind that investing in shares involves more risk than in a cash savings account. Companies can face competition, adverse trends, or new regulation that can harm their businesses.
But that’s why I’d spread my risk by owning multiple dividend shares across various industries.
How I’d invest £20,000 today
If I was targeting passive income for 2024 and beyond, I’d buy 10 dividend stocks worth £2,000 each.
Some of my shares would immediately offer above-average dividends, but some would focus on dividend growth to grow my income over time.
In each case, I’d focus on fundamentally sound businesses. By this I mean they should have a solid business model with stable earnings.
I’d also check if the payouts are affordable by looking for a dividend cover greater than 1.2. This shows how many times its dividend can be paid by a company’s current earnings.
What I’d buy
Right now, if I had cash for this strategy, I’d buy IG Group, Rio Tinto, Barclays, Sainsbury’s and Kingfisher for immediate high dividend income. On average, this group offers a 6% dividend yield and a cover of 2.2.
For dividend growth, I’d buy BAE Systems, Diageo, Coca Cola, Cisco Systems and JPMorgan Chase. This group offers a yield of 3% and a dividend cover of 2.4. This selection also offers 19 years of back-to-back dividend growth.
