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The idea of earning passive income from a Stocks and Shares ISA is a pretty simple one. Many large, successful companies pay shareholders cash in the form of dividends. So by investing an ISA in a mixture of high-quality dividend shares, it ought to be possible to earn some passive income on a regular basis.
As with any passive income plan, there could be bumps along the road. No dividend is ever guaranteed to last. That is why such a plan envisages diversifying across different companies and always paying close attention to the quality of each investment.
But with the right approach I think a Stocks and Shares ISA can be turned into an income powerhouse!
A formula for income
How much depends on a couple of basic factors: the amount invested and at and the dividend yield. Yield is basically how much someone receives annually in dividends, expressed as a percentage of what they paid for their shares.
Yield is not fixed, as dividends are not guaranteed. But that is not always bad news: a dividend can be cut, but it can also grow. Some FTSE 100 firms have grown their dividend per share annually for decades.
At the moment, the FTSE 100 yields 2.9%. But I think a higher yield of 5% is possible, while sticking to proven blue-chip companies.
£500 a month adds up to £6k a year of income. At a 5% yield, that would require a Stocks and Shares ISA worth £120k.
But it is possible to start with far less – in fact zero. Putting in £20k a year and compounding it at 5% annually, the ISA would be worth over £120k after six years. At a 5% yield, the ISA should then be more than able to hit the income target of £500 a month, on average.
Choosing an ISA
For most investors, £20k is within the annual contribution allowance for a Stocks and Shares ISA.
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.
Different ISAs have their own fee structures. Those can eat into returns, so it is important to take some time to compare options when choosing a Stocks and Shares ISA.
Could this dividend share be turning the corner?
One share I think investors should consider for its passive income potential is Pets at Home (LSE: PETS). It currently yields 6.3%. The share price performance has been awful, falling 49% in the past five years.
That has been partly down to challenges getting the right product selection on shelf at an attractive price. I see an ongoing risk management could get that wrong.
But a trading update this week helped boost investor sentiment. The most recent quarter still saw retail revenues falling, but there were early signs the company sacrificing some profit margin to make prices more competitive may be starting to improve sales volumes.
Meanwhile, not only was the news for the retail business encouraging, but the FTSE 250 company has a large chain of vet practices that has been growing strongly. That division saw revenues grow 5% year-on-year in the quarter.
The company benefits from a sizeable customer base and has an active loyalty programme I think can help keep them coming back for more.
