This £20k ISA delivers £1,961 of cash passive income a year

As a long-term investor, I like buying shares in good businesses at fair prices. Also, my investing style nowadays favours value shares and passive income. Thus, when share prices plunge — as they did during the recent market meltdown — I see these falls as opportunities to buy at a discount.

Hence, I’m often drawn to cheap shares offering market-beating dividend yields to patient shareholders. As my family doesn’t need this income right now, we reinvest our dividends by buying more shares. Over time, this increases our corporate ownership and boosts our total long-term returns.

Passive income from dividends

Though share dividends are my favourite form of passive income, they’re no sure-fire route to riches. Indeed, returns from value/income investing have lagged behind those from growth investing for most of the last 15 years. Also, these three problems can cause problems:

1. Future dividends aren’t guaranteed, so they can be cut or cancelled at short notice. For example, during 2020-21’s Covid-19 crisis, dozens of UK companies slashed their payouts to preserve cash.

2. After paying out dividends, companies have less cash at hand. Therefore, paying out excessive dividends can weaken companies over time.

3. Super-high dividend yields, say, 10%+ a year, can warn of future problems. History has taught me that double-digit cash yields rarely last. Either share prices rise, or dividends get cut, dragging down yields.

Three dividend dynamos

These three shares offer the highest passive income from FTSE 100 stocks:

Note that these Footsie firms are all asset managers — they manage other people’s money and financial assets. This was a pretty good business to be in since the global financial crisis of 2007-09 ended. However, with fund fees under relentless pressure from passive index-tracking funds, profit margins aren’t what they used to be.

Overall, these three shares deliver an average dividend yield of 9.8% a year. Therefore, a mini-portfolio of equally weighted holdings in all three stocks would generate passive income of £1,961 annually. Furthermore, this cash stream would be tax-free inside a Stocks and Shares ISA.

I like M&G

For the record, my family portfolio includes all three dividend shares listed above. My wife and I bought these stocks for their bumper dividend yields, which we reinvest for growth.

In particular, I like the look of M&G as a long-term producer of passive income. M&G was founded in 1931 and launched the UK’s first unit trust that same year. The current share of 186.75p translates into a huge cash yield of 10.8% a year. But this yield has leapt due to recent falls in the M&G share price. This is down 13.4% over one month and 7.2% in a year, but is ahead 43.4% over five years (excluding dividends).

Then again, what if things turn sour again for financial markets, as happened recently? With £312bn of assets under management, M&G’s profits and cash flow could get slammed if stock and bond prices plunge further. Even so, I note that its yearly dividend has risen from 15.77p a share for 2019 to 20.1p for 2024. In short, this passive income looks sound to me!

The post This £20k ISA delivers £1,961 of cash passive income a year appeared first on The Motley Fool UK.

More reading

• Down 15% in a month, this FTSE 100 dividend share offers investors a stunning 10.8% yield
• £9K of savings? Here’s how an investor could target £490 a month of passive income
• Is now a good time to start buying shares?
• Income of almost 12%! 3 stunning FTSE dividend stocks now have double-digit yields
• These FTSE 100 dividend stocks have 9% yields!

The Motley Fool UK has recommended M&G. Cliff D’Arcy has an economic interest in all three shares mentioned above. 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.

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.

See author's posts