How I’d use a £20,000 Stocks and Shares ISA to generate a four-figure income

Young woman working at modern office. Technical price graph and indicator, red and green candlestick chart and stock trading computer screen background.

Tucking money away in a Stocks and Shares ISA today could hopefully let me benefit from capital growth in years to come. But it might also be the source of a four-figure annual income, if I invest in shares paying dividends. Here is how I would go about spending £20,000 in the stock market with that target in mind.

Find the right dividend shares for me

Different investors each have their own objectives and risk tolerance. So what suits one may not be right for another. I would therefore try to find some dividend shares I could buy for my portfolio that meet my own investment objectives.

£20,000 is enough to diversify across a range of shares, so I would probably put £2,000 into each of 10 different shares. That way, if its future dividends disappoint me, the overall impact on my passive income streams would be limited.

To find those shares, I would not start by looking at their dividends. Instead, I would hunt for businesses I understood that I felt had a sustainable competitive advantage. Such an industry edge could help them make profits in future. Profits are the basis for a company paying out dividends.

Possible choices for my Stocks and Shares ISA

What types of shares would I consider, using this approach?

An example would be the drinks maker Diageo. As the owner of brands like Guinness and Johnnie Walker, it has a competitive advantage as no rival’s products taste exactly the same. That gives it pricing power, which in turn could enable it to maintain profits and pay dividends. Indeed, Diageo had raised its dividend annually for over three decades. That is no guarantee of what will happen to the dividend next — but the strong business fundamentals give me confidence about the outlook for Diageo’s profitability.

Falling alcohol sales in some markets could be a risk to revenues and profits in future, though. It is exactly to reduce the impact of such risks that I would build a diversified ISA of dividend shares.

Targeting a four-figure annual income

Is it realistic to target a four-figure annual passive income from shares?

I think it is. Such an income would be £1,000 or more. If I invested £20,000, I could earn that by holding shares with an average dividend yield of 5% or higher. As that is an average, not all shares need to yield that much. For example, Diageo only yields 2.1%. But I would consider buying it for my Stocks and Shares ISA, along with higher-yielding choices.

Doing so might give me a blend of high-yield picks along with shares I felt likely to grow their dividends not just maintain them at their current level. Hopefully that could be enough to hit my minimum 5% average yield target — and start earning a four-figure annual passive income.

The post How I’d use a £20,000 Stocks and Shares ISA to generate a four-figure income appeared first on The Motley Fool UK.

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Christopher Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.