One of the things I like about investing in a Stocks and Shares ISA is it gives me the opportunity to earn passive income from dividend shares.
If I wanted to invest a £20,000 Stocks and Shares ISA today with an eye on dividends, here is how I would go about it.
Income focus
Broadly, shares are often described as growth or income shares. In reality however, some shares offer both growth and income prospects. That can be attractive, as income on its own is not always enough to make a share attractive.
For example, from an income perspective, 8.7%-yielding Direct Line looks attractive to me. But over the past year, its share price has fallen 13%. So if I had put money in Direct Line shares a year ago, I would currently be nursing a paper loss, despite the large dividend.
So I would try to decide how focussed I wanted to be on income. Some high-yielding income shares, such as tobacco company Imperial Brands, offer limited growth prospects over the long-term. That does not mean it might not still be a good choice for my Stocks and Shares ISA.
But I think it would be helpful for me to bear in mind that if I wanted to try and earn very high dividends from my £20,000, that may mean I end up buying shares with limited growth prospects.
Dividend shares that can stay the distance
Dividends are basically the way in which a company pays out some or all of its earnings to shareholders. So to pay dividends year after year, a company needs to be profitable.
I would therefore look for companies that are, and could well keep making money in years to come. To do that, it helps if a firm is in a market that should still be around for a long time. For example, companies such as M&G and Legal & General make their money in the financial services market.
But I would also want to invest in companies that have some unique ability to compete in their chosen market. Take National Grid as an example. Its large infrastructure of energy distribution networks would be very costly and perhaps impossible for a competitor to build from scratch. That gives National Grid a unique competitive advantage. Currently its dividend yield is 4.4%.
Diversifying my Stocks and Shares ISA
No matter how promising such companies seem to me, unexpected events could hurt their earnings in future. To help reduce the risk that could pose to the dividend streams I am hoping to build, I would diversify my Stocks and Shares ISA.
£20,000 is plenty of money to diversify. I could put £2,000 into each of 10 stocks, for example. As well as buying different shares, I would also try to make sure I was exposed to a range of different industries.