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One approach to trying to build passive income streams is stuffing an ISA full of dividend shares.
How successful that is depends on a number of things, including what shares you buy, what their dividend yield is (and whether it moves higher or lower over time), fees for the ISA and the timeframe involved. Even when focusing on dividends, capital gains or losses can also affect the overall return.
In other words, there are a lot of moving parts. So let me go through them one by one.
Finding shares to buy
Some shares offer higher dividend yields than others. But dividends are never guaranteed, so it is always important to consider how sustainable a dividend seems.
In addition, diversifying the ISA across different shares reduces the risks if one of them turns out to disappoint.
Dividend yield and its role
Yield is the amount of passive income in the form of dividends that is earned in one year, expressed as a percentage of the price paid for the shares.
So at the current FTSE 100 yield of 3.3%, a £20k ISA ought to earn £660 in dividends annually.
ISA fees, commissions and costs
What may look like a small annual cost for the ISA – say 1%, or 0.5% — can eat into returns substantially over time. On top of that there may be fees, commissions, taxes and even other charges.
So it is a smart move to compare different Stocks and Shares ISAs when assessing which one suits an individual’s needs best.
Timeframe matters
Most investors have an annual ISA contribution allowance of £20k. Even if they can beat the current FTSE 100 yield and achieve, say, 7% (which I think is achievable in today’s market), 7% of £20k is £1,400 a year of passive income. That is something, but far off the £12k annual amount required for an average monthly passive income of £1k.
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Taking a long-term approach to investing can help. Putting in £20k a year and compounding it at 7% annually, after seven years the ISA ought to be worth over £173k. At a 7% yield, that would generate over £1k a month on average as passive income.
One share to consider
I said I think a 7% yield is achievable. One share I think passive income investors should consider is 8.7%-yielding FTSE 100 insurer Phoenix Group (LSE: PHNX).
Its dividend per share has grown annually in recent years and the company aims to keep raising it every year too.
The share price movement has been less attractive though, with the Phoenix share price moving down 6% in the past five years, a period during which the FTSE 100 index has gained 58%. But I think that means the current price may continue to offer good value.
With brands like Standard Life in its stable, Phoenix has a proven business model of running pension schemes and retirement-linked financial investments for around 12m UK customers. The business model is highly cash generative, which is good news when it comes to funding dividends.
One possible fly in the ointment could be a weakening UK economy hurting asset prices, forcing Phoenix to write down the value of some investments more than is currently anticipates in its planning models. But from a long-term perspective, I think Phoenix could potentially remain a passive income powerhouse.
