How to use a £20k ISA allowance to invest for passive income

We’d all love to earn some passive income, wouldn’t we? I mean, who wouldn’t want regular cash coming in that we don’t have to work for?

I reckon the annual £20,000 ISA allowance is great for those of us investing for the long term. All of the profit we make in an ISA is tax-free, even for those who’ve built up a million or more in their accounts. (And thousands have achieved that, by the way.)

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 can we earn?

One thing I love about an ISA is that it’s flexible. We often hear the old saying that we shouldn’t let the tax tail wag the investment dog, and that can make sense. A poor investment remains a poor investment even if we don’t pay tax on it.

But an ISA is just a wrapper, and we can use it to protect a whole range of investments. How well we perform is entirely our own responsibility.

For me, the choice of what to go for is easy. It’s a Stocks and Shares ISA every time, even if it gives me more risk to have to deal with. In the past decade, Stocks and Shares ISAs have averaged 9.6%. In 2019-2020, however, we saw a painful 13% loss.

But then, over the past 20 years, average annual returns from the FTSE 100 have come in at 6.9%. And that’s close to the very long-term rate.

Stocks to consider

So that’s the first thing. I think investing in the stock market needs a horizon of at least 10 years, ideally 20 or more. Over that timescale, the chance of stocks losing out to cash becomes increasingly low.

There are two other key ways to address risk. One is diversification, putting our cash into a wide range of companies in different businesses. The financial crash? The pharmaceuticals and energy sectors were fine, for example.

And then I try to invest in top companies in industries that seem like they could go on for ever. Ideally, they’ll have a defensive moat, generate strong cash flow, and pay steady dividends.

I’m looking at National Grid (LSE: NG.) as a passive income buy candidate. The dividend yield is forecast at 5.9%, which is close to that 20-year FTSE 100 return on its own.

Cash cow essential

National Grid provides an essential service, and it’s well protected against competition. But there’s a side to it that I like less. It’s the costs of maintaining and developing its network in the years ahead.

A new £7bn rights issue to help fund its plans led to this summer’s share price dip. If it happens again, it could drop the share price again. And it might even hit the dividend.

Against that, National Grid generated £7.3bn in cash flow from continuing operations in its last full year. And that’s just what I want to generate long-term passive income for me to reinvest for the future.

Individual investors need to develop their own investing approaches. But this is the kind of stock I go for in my diversified ISA.

The post How to use a £20k ISA allowance to invest for passive income appeared first on The Motley Fool UK.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended National Grid Plc. 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.