The idea of earning extra income without working for it appeals to me. That is why I invest in dividend shares. Rather than let my Stocks and Shares ISA allowance go unused, if I had a spare £20,000 right now, this is how I would spend it buying shares I thought could set up passive income streams for the long term.
High income, growing income or both
As a long-term investor, I would be putting my ISA to work not just for now but also with an eye on the years ahead. So I would think about what my objective was when it came to income.
That may sound obvious – I would like lots of it! In reality though, there are a few more nuanced questions I might helpfully consider.
For example, although dividends are never guaranteed, would I prioritise jam today or jam tomorrow? Some dividends are large but flat – Jupiter is an example from my own portfolio. Others are much smaller but growing. For example, DCC has a yield of 3.6%, just a fraction of the 16.7% offered by Jupiter. But it has raised its dividend annually for well over two decades.
I might also consider whether I would be willing to invest in cyclical industries. These can offer high dividend yields in good years, but when commodity selling prices fall those often drop. For example, the 11% dividend yield of Rio Tinto looks attractive to me now. But if metal prices fall sharply, I expect the annual dividend will be cut deeply.
Investing in great companies
But yield is always just one part of the story. To sustain a payout, a company needs to generate enough extra income to fund it. For example, while the Jupiter yield right now looks eye-popping, its first half earnings did not cover it. If Jupiter cannot improve its business performance, I see a risk of a dividend cut.
That is why when looking to invest in my Stocks and Shares ISA I would try to find businesses I thought had a sustainable competitive advantage in a resilient market.
With £20,000, I could diversify my portfolio across five or even 10 such companies. Finding 10 great businesses I can understand that sell at an attractive share price today may be a challenge. So I would be willing to keep some or all of the money sitting in my ISA until I found income stocks that felt right for me. Remember, I am investing for the long term. Patience is critical to doing that successfully.
Reinvesting dividends in my Stocks and Shares ISA
As £20,000 is a substantial sum, hopefully it could earn me a decent amount in dividend income each year. At a 5% average yield, for example, my earnings could be £1,000 each year.
But rather than take them out, what if I simply left them in the ISA and compounded them? That could help me grow my future income streams even more – which is why I would do it.
If I hold my shares and keep reinvesting, hopefully I would be generating passive income for decades.