Image source: Getty Images
At this time of year, some more money could come in handy for many of us. Passive income is a way of describing money that is earned without working for it. That may sound too good to be true, but it can be as simple as using a Stocks and Shares ISA to invest in some blue-chip businesses that pay dividends.
With a long-term mindset, such an approach can potentially earn hundreds (or even thousands) of pounds in passive income each month.
Dividends can earn dividends… that earn dividends!
For example, imagine somebody sets up a Stocks and Shares ISA with £20k then is able to grow its worth at a compound annual growth rate of 7.5%.
After 19 years (remember – I mentioned a long-term approach to investing is helpful here), that ISA ought to be worth around £79k.
In other words, in slightly less than two decades, its value should nearly have quadrupled thanks to the power of compounding – dividends earning dividends.
Capital growth could have helped too, although share prices can move down as well as up – and dividends are never a sure thing.
At a 7.5% dividend yield, that Stocks and Shares ISA would then be big enough to earn passive income of around £5,927 a year. That averages out to around £493 a month.
Setting realistic expectations – and taking action
Is a 7.5% compound annual growth rate realistic? After all, the FTSE 100 yield currently stands at a far more modest 3%.
I think that target is achievable – and realistically so – in today’s market.
I do not think aiming for it ought to require investing in little-known businesses. It should be achievable with a suitably diversified portfolio of well-known and proven blue-chip firms.
Another helpful factor could be keeping a keen eye on dealing costs and management charges, so it makes sense to look around for the most suitable Stocks and Shares ISA.
Dividend yield well above average
As an example of what such an approach might look like in action, one income share I think investors should consider is British American Tobacco (LSE: BATS).
When it comes to income, for investors who do not have an ethical objection to the line of business, the tobacco industry has some attractions.
Cigarettes are cheap to make but can be sold plentifully for a pretty penny. With limited avenues for growth, tobacco manufacturers can use cash flows to fund dividends.
British American is a case in point. It has grown its dividend per share annually for decades.
The firm’s premium brands give it pricing power: Pall Mall is a pricey proposition whether on a tobacconist’s shelf or an estate agent’s listings!
The current dividend yield is 5.7% — and British American’s share price has gained 54% in five years.
Falling cigarette sales are a risk to profits. But pricing power can help the company mitigate falling sales volumes by increasing the price tag.
Meanwhile, the FTSE 100 business has also been growing its non-cigarette business with products like Velo nicotine pouches.
