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It’s estimated that approximately 15% of UK adults have a Stocks and Shares ISA. Many of these individuals will be using them to buy dividend shares to help provide a second income. As an added bonus, this cash can be enjoyed tax-free.
So without having to work for it, how much would someone need in an ISA to earn an extra £300 a month? Let’s take a closer look.
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.
What’s achievable?
The answer to this question depends on the level of return achieved. For example, the FTSE 100 currently (5 February) has a historic yield of 3.1%. With a return like this, an ISA would have to be worth £116,129 to meet our £300 a month target.
But I reckon it’s possible to achieve a higher return by carefully choosing a diversified selection of high-yielding stocks. The 10 highest on the index are currently offering 6.4%, meaning our portfolio would need to be worth £56,250 to achieve our objective.
Of course, dividends cannot be guaranteed. However, there are plenty of stocks that have a long history of steadily increasing their payouts and offering above-average returns.
An impressive track record
One such stock is British American Tobacco (LSE:BATS). It’s established a reputation for not only being a generous dividend share but also a reliable one. In fact, it last cut its payout in 1999. At the moment, the stock’s yielding 5.3%.
There’s a handy calculator on its website that shows that someone investing £10,000 on 1 January 2016 would have received 37 dividends – worth £5,753 — over the 10 years to 31 December 2025. I reckon a return of 57.6% from doing nothing is amazing.
But here’s the clever bit. If these amounts had been reinvested buying more BAT shares, another 271 would have been purchased over the period. This investment technique’s known as compounding. Over the decade, it means payouts of £7,978 would have been generated. That’s an overall return of 6.04%.
At this level, an ISA valued at £59,603 would produce the equivalent of £300 a month (£3,600 a year) in dividends. Whether an investor chooses to treat this as a second income or to buy more shares is a matter of personal preference dictated by their circumstances. But either way, it’s nice to have the choice.
Pros and cons
Armed with this information, I can see why BAT is a popular share with income investors. However, it doesn’t appeal to everyone.
For a start, it’s a ‘sin stock’, which is likely to put off ethical investors.
And then there’s the health-related threats to its long-term revenue stream. Traditional cigarette smoking is in decline so the group’s investing heavily in other so-called ‘reduced-risk’ alternatives.
It plans to be a “predominantly smokeless” business by 2035. And although their popularity is increasing, these new products are still a long way from producing the same level of revenue and earnings as conventional cigarettes. Ultimately, its dividend could come under threat although there’s no sign of this happening just yet.
However, because of this potential long-term threat to its business, the stock’s not for me. Having said that, this doesn’t stop me admiring its income-earning properties. Personally, to earn £300 a month in passive income, I’d look elsewhere. Fortunately, there are loads of other high-yielding dividend shares on offer right now.
