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When people first learn about the idea of passive income, they sometimes start thinking about setting up some sort of business that hopefully can more or less run itself. But there is more than one approach to trying to earn passive income. One is to use an ISA to buy shares in blue-chip companies that pay dividends to their shareholders.
While such an approach may not involve working, it can involve risk. Dividends are never guaranteed to last – and share prices can fall.
However, it can also be a lucrative approach. It offers the benefit of flexibility too, as it can be tailored to an individual’s available means.
Setting a passive income goal
How much such an approach might generate depends on several factors.
One is the amount invested. Another is the dividend yield, which is basically the annual dividend income expressed as a percentage of the initial investment.
So, for example, at a yield of 10%, targetting £3k per month (£36k per year) of passive income would require an investment of £360k.
A 10% yield is rare. But a yield of half of that (5%) is not uncommon. It is higher than the current FTSE 100 yield of 3% but I think it Is achievable in today’s market even sticking to high-quality businesses.
That would require £720k of money in the Stocks and Shares ISA to generate the targeted amount of passive income.
That money could be a lump sum, or someone could make regular contributions and reinvest dividends to help speed the process of building up money in the ISA. That is known as compounding.
What works for one person may not suit another
That is a lot of money to invest. Some people may have more modest targets, or means.
One of the things I like about using an ISA as a way to generate passive income streams is that I can cut the coat according to my cloth.
That can mean putting in a small amount of money each month, for a more modest passive income goal. Over time, even fairly small sums can add up.
One income share to consider
One of the shares I think an ISA investor trying to build a second income should consider is insurer Aviva (LSE: AV).
At the moment, the FTSE 100 firm offers a dividend yield of 5.4%.
It has been growing the dividend per share handily over the past few years, following a sharp cut in 2020.
Insurance is a time-tested industry with resilient demand and ongoing profit potential. Aviva can hopefully benefit from that, as the country’s leading insurer. It has a large client base, well-known brand, and economies of scale thanks to its leading market position.
All shares carry risks and, indeed, Aviva’s dividend-cutting history is a practical reminder that no dividend is ever guaranteed to last. One risk I see as the company continues to integrate the Direct Line business it bought this year is that that could distract management attention from the core business.
Still, as a long-term investor, I see Aviva as a solid business with promising prospects.
