How much income could a £20k ISA generate in a year?

The idea of putting an entire year’s Stock and Shares ISA contribution limit into a single investment would scare me. Unless, that is, I’d already built up a large and diversified portfolio and the £20k wouldn’t be just a proportion of it.

Even then, if I had to pick just one, it might have to be something like City of London Investment Trust (LSE: CTY). Yet while it’s a diversified investment trust, it still has its risks. It is, after all, a company in itself with a single management team.

And if it failed to raise its dividend one year, I reckon the share price could tumble.

Long-term dividends

Dividend rises are especially key here, as this trust has increased its annual cash payout every year for the past 58 years. Seeing that falter could be painful.

But the diversification makes this as close to a ‘buy-and-forget’ stock as I can think of. It’s effectively the same as buying a collection of shares in HSBC Holdings, Shell, BAE Systems… and all the other top-drawer UK stocks it holds for income generation.

And with a forecast dividend yield of 4.5%, I’d say it’s a good one to use to try to answer my headline question. So how much could I earn from it?

On the face of it the calculation seems straightforward. If I pony up my £20k and get a 4.5% dividend yield, I’d earn £900 in income in a year. But that’s just the start of the story.

The years ahead

I don’t actually want to take any income from my ISA at the moment. Instead, I let my dividend cash build up until I have enough for another share purchase… and back in it goes.

In the first year I’d have that £900 to reinvest. But if I bought more of the same, in the second year I’d get £940.50. The extra £40.50 would be the 4.5% dividend I’d get from the extra £900. And then in year three I’d earn £982.82. And so on, with each year’s dividend payment getting bigger and bigger.

By the time I reach 10 years, my initial £20k could have grown to £31,060. And that’s without investing a further penny over the decade. Stick with it for another decade, and my pot could reach £48,230.

Compounding magic

The first 10 years could make me a profit of £11,060. But the second 10 years could add another £17,170. And that’s why many investors see compounding as their best friend. This example shows how later years can make more money than early years, and reinforces the importance of investing for the long term.

Oh, I haven’t considered any share price gains here. In reality, I’d expect the annual dividend to rise and the share price to go along with it and keep the yield roughly stable. And that could give my long-term hopes a further boost. Not that any of this is guaranteed however.

But I reckon a stock like this is a good one to consider for investors starting their first ISA… though perhaps not with their full allowance.

The post How much income could a £20k ISA generate in a year? appeared first on The Motley Fool UK.

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HSBC Holdings is an advertising partner of Motley Fool Money. Alan Oscroft has positions in City Of London Investment Trust Plc. The Motley Fool UK has recommended BAE Systems and HSBC Holdings. 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.

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