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A Stocks and Shares ISA is a great tool for an investor to build a second income from dividend shares. Yet the point isn’t just to buy one stock that pays out income and then benefit from that. Holding several shares can help diversify risk and provide a smoother stream of cash over time. Here’s an example portfolio for investors to consider.
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How to start building the pot
To begin with, I think an investor should figure out the target yield they would be happy with. Based on a variety of factors, I’d suggest considering a 7% dividend yield. This is high enough to warrant active investing versus simply buying a FTSE 100 tracker. Yet it’s not crazy high to the point that an investor would have to include some pretty risky stocks as well.
The next step is to look for dividend shares with a current yield around the target level. Given that this is a six-stock portfolio, an investor can afford to include ideas with yields higher and lower than 7%, as the average blended yield is what we’re really focused on. Within the FTSE 100 and FTSE 250 there are more than two dozen options in this ballpark to consider.
It’s important to ensure the picks aren’t all concentrated in the same sector or serving similar clients. This allows the portfolio to be truly diversified. If the portfolio held similar stocks and an issue impacted their sector, the hit to dividends could have a much larger effect than if they were spread around various areas.
Finally, once the six are selected, regular investment over time can increase the income potential. When a dividend gets paid, reinvesting it can allow for future gains to compound at a faster pace.
Ideas to think about
Based on the above filters, a six-stock portfolio could include Pennon Group (LSE:PNN), Aviva, WPP, Assura, Dowlais Group, and BP. The average yield on this portfolio would currently be 7.1%.
One company in particular worth looking at is Pennon Group, with a 7.2% yield. Over the past year, the stock is down by a modest 2%. The UK-based environmental infrastructure company mainly generates revenue through its water and wastewater services. Yet it also is investing heavily in renewable energy, as one way to future-proof the company.
The stable nature of cash flow from water provisions means that I don’t see the dividend under threat anytime soon. The company policy is to grow the dividend payments by the inflation rate plus an extra 2%. This means that investors can be confident of generating a real return even after adjusting for the impact of rising prices.
However, investors need to be aware of the real risk that reputational damage can cause. The cryptosporidium contamination incident in Brixham last year cost tens of millions of pounds, on top of a tarnished reputation.
Potential future benefits
If an investor put £250 a month in each of the six stocks, the pot could quickly grow in size. Assuming a constant dividend yield of 7.1%, year 11 could look quite rosy after a decade of reinvestment. With a potential pot size of £264k, it could generate £1,545 in income each month.
