Image source: Getty Images
The Stocks and Shares ISA offers ordinary people a brilliant way of generating a second income, without breaking sweat. There’s no tax to pay on it either.
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.
They can do this by investing in UK blue-chip shares, most of which pay regular income to investors in the shape of dividends. The easiest way to tap into this is to buy a FTSE 100 tracker. That’s the work of seconds, and a good place for beginners to start.
Let the dividends compound
Today, the index yield is 3.25%. At that rate, somebody wanting to generate a passive income of £888 a month, which adds up to £10,656 a year, needs a portfolio worth £327,876. However, if they could up that yield to 5.5%, they’d slash that target to £193,745.
Investors can target a higher rate of income by picking up a spread of FTSE 100 stocks with above average yields. This takes a bit more effort than simply buying a tracker, but once an investor has picked those stocks, they can sit back and let the income quietly compound away.
Rio Tinto has a high yield
Globally diversified mining giant Rio Tinto (LSE: RIO) has a strong dividend track record, and currently offers a trailing yield of 5.65%. That’s highly tempting but investors need to do their research here.
Commodity stocks like this one are famously cyclical. They boomed when China was modernising and industrialising at speed, and gobbled up the world’s supply of metal and minerals. But as the world’s second biggest economy slowed, so did demand. It doesn’t help that the US is slowing too.
The Rio Tinto share price has idled for some years, although it’s showing signs of life today, jumping 25% in the past six months. Over one year, it’s up just 8%.
Dividend progress hasn’t been smooth. Investors got a total payout of 793 US cents per share in 2021. Three successive cuts reduced that to 402 cents for 2024. However, the yield is still high for new investors. Rio also has a habit of accelerating payouts when conditions improve.
A cyclical sector
There are potential bright spots as the copper price climbs as energy transition projects and AI data centres soak up supply. The group remains on track to meet production goals this year, with copper and bauxite output climbing, although iron ore has been flat. Rio Tinto has a huge opportunity in lithium, via its $2.4bn Jadar project and last year’s $6.7bn purchase of ACRadium Lithium.
One advantage of recent disappointing performance is that the shares look decent value with a price-to-earnings ratio of around 10.7, well below the FTSE 100 average of roughly 17. I think Rio Tinto is worth considering for income-focused investors who are willing to put up with short-term volatility in the share price.
Of course, this is just one stock. Over time, investors need to build a balanced portfolio are around 10 to 15 shares. It does take a bit of time and research, but it’s minimal effort for the amount of passive income investors can generate. Every penny tax-free for life, inside the Stocks and Shares ISA.
