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Just how much passive income could someone earn by using an ISA to build up a portfolio of dividend shares?
The question is a bit along the lines of asking how long is a piece of string.
That is because the passive income streams someone might generate depend on how much they invest, what their average dividend yield is and their timeline.
To keep things simple, I will use an example that keeps the first two variables the same.
Imagine someone is investing £3k in an ISA.
Now imagine that they earn an average dividend yield of 6%. That is well above the current FTSE 100 yield of 2.9%, but I think it is still possible in today’s market while sticking to high-quality blue-chip shares.
Taking the long term approach
The one variable left in this example, then, is timframe.
Say the investor wants to start earning passive income as soon as possible. A 6% yield on £3k should generate £180 of dividends annually.
Payouts are not always evenly spaced, but at that rate, it is possible that they could earn £90 of passive income within the next six months or perhaps a bit longer, depending on when in the annual cycle shares pay dividends. That is different for different shares.
But what if they are willing to wait longer, reinvesting dividends (we call this compounding) until the pot is big enough, then taking them out as passive income?
Doing that, the initial £3k could have grown to a size big enough to generate £900 of passive income annually after 28 years. Or, if someone was willing to wait 68 years, they could earn £9k of passive income per year.
I know: 68 years is a long time to wait, even for a long-term investor. But if a parent started investing for a new baby, it becomes a reasonable timescale.
The point is that an investor can choose what timeframe suits them. They can also decide how much to invest.
There are variables in terms of how much passive income they may earn, but I like the flexibility of owning dividend shares for such income.
Getting started can be easy
With cash to hand, or saved it up over time from zero, one could start investing. But that requires a way to buy and hold shares.
Different ISAs have different structures. Fees and commissions could eat into returns even across the next year, let alone the next 68!
So it pays to take time when comparing available Stocks and Shares ISAs.
Finding dividend shares to buy
An investor also needs to decide which shares to buy. Dividends are never guaranteed to last, even if they are juicy now.
One income share I think merits consideration, for investors who do not reject it on ethical grounds, is British American Tobacco (LSE: BATS).
The owner of brands like Pall Mall cigarettes and Vuse vapes has a global footprint, economies of scale and premium brands with pricing power.
So the company is able to generate chunky free cash flows to help fund dividends. It yields 5.5% — and has grown its dividend per share annually for decades.
Declining cigarette use is already eating into revenues and is also a risk to profits.
But the business’s pricing power and non-cigarette expansion could help it adapt.
