A Stocks and Shares ISA can be a useful tool for earning substantial dividend income. If I had £20,000 to invest in an ISA and wanted to earn income, here is how I would try to do it. With this approach, I could hopefully generate a bit more than £1,350 each year in dividends. That is an average dividend yield of almost 7%.
Investment principles
Dividends are never guaranteed. Just because a company has paid out handsomely in the past does not mean it will do so again.
For that reason, I would split my money across a number of companies. If one of them cut its dividend, the overall impact on my income would be limited. For the same reason, I would not put too much of my Stocks and Shares ISA into a single sector.
I would put £2,500 into each of eight shares as follows.
Sin stocks
First up, I would buy two so-called sin stocks with different dividend profiles.
With a yield of 6.3%, the income appeal of British American Tobacco is clear. It has also grown its annual dividends for more than 20 years. But declining cigarette use could hurt revenues and profits. Another serial dividend raiser is Johnnie Walker owner Diageo. I think its long-term growth prospects are strong. Its yield is only 2% today — but future dividends could grow if business performance remains good.
Financial services
In the financial services sector, I like asset manager M&G with its 8.6% yield. An economic downturn might lead to clients investing less, which may hurt profits. But a strong brand and large customer base are strengths I think could help M&G.
The same logic applies to insurer Direct Line. I like the fact that even in a recession, demand for insurance tends to be robust. One risk is lower profit margins due to rules on renewal pricing. But I see Direct Line as well positioned and experienced in its marketplace. The shares yield 9%.
Consumer goods
I would also buy Domestos maker Unilever for its sparkling 4.1% yield. The consumer goods giant has a portfolio of premium brands and global reach. Both those things could help it combat the risk to profits posed by cost inflation.
Further down the supply chain, I would add Tesco to my shopping basket too. The retail giant yields 4.2% and I like its defensive qualities. Increased competition could hurt profit margins, but I expect sales to stay strong at the market-leading grocer for years to come.
Income shares to buy now for my Stocks and Shares ISA
My final two choices are the highest-yielding of all my picks.
Homebuilder Persimmon yields 10.9% at the moment. I think that reflects mounting investor concerns that a housing market pullback could hurt Persimmon’s profits. While I do see that as a risk, I think the well-run company could continue to be successful in coming years.
Finally I would invest in venture capital trust Income & Growth. It invests in a variety of small and medium-sized enterprises. That offers me exposure to a diversified range of companies. Those businesses’ growth could be uneven or may not happen at all. But with its 9.8% dividend, I think Income & Growth would make an attractive income pick for my Stocks and Shares ISA.