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For investors seeking to build long-term passive income, I think considering buying cash-cow dividend shares in a Stocks and Shares ISA is up there with the best ideas ever.
The key is to reinvest the annual dividend cash and let the magic of compounding grow the total year after year. And putting it in an ISA means we can invest up to £20,000 each year and not pay a in penny tax when we finally take it out — no matter how much we accumulate.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Nearly 10% a year
Today, I’m using TwentyFour Income Fund (LSE: TFIF) as an example to see how much we might be able to earn with this strategy. It’s currently on a forecast dividend yield of a whopping 9.9%. And that alone would be enough to bring in £1,980 in the first year.
But here’s where it really gets interesting. If we put that £1,980 to work by buying more TwentyFour Income stock, we’d be starting the next year with £21,980 in shares. And assuming the dividend yield stays the same, our second year of dividend income would amount to £2,176.
The year after that we could have another £2,391 dividend cash to reinvest in new shares.
And by the 10th year, we could be up to an annual £4,631 and still rising. That’s a 23% return in one year on the initial £20,000 investment — and without putting in even a penny of extra cash. Invest more each year, and our returns should multiply further.
Share performance
The share price is up only around 12.5% since the fund was launched in 2013. It seems we’re sacrificing capital gains for dividends. And it’s a shame the shares haven’t risen much in 12 years to add to our profit. Or is it?
Billionaire investor Warren Buffett once famously asked: “If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef?“
The answer seems clear, yet many investors get it wrong when they think about shares. If we plan to keep investing over the long term, we can buy more if prices fall. So the lackustre performance of the TwentyFour Income share price could actually boost our long-term gains by enabling us to build up a bigger pile of shares.
No guarantees
It’s time for a few cautions. No dividends are ever guaranteed. But this one does have a decent track record. It’s a bit up and down, but the general trend is up. Remember however, there’s always a risk of dividend cuts.
This fund invests in asset-backed securities, including mortgages, loans and debt-based derivatives. And I wouldn’t put too much of my investment cash into something as risky as the debt market. Some of the things the fund buys are quite complex and come with some danger.
So I’d spread my risk across a range of companies in different businesses. But I do think investors could do well to consider TwentyFour Income fund as part of a diversified ISA portfolio.
