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How I’d invest £20,000 in a Stocks and Shares ISA to generate extra income for life

Young Caucasian man making doubtful face at camera

The idea of earning extra income without working for it appeals to me. That is why I invest in dividend shares. Rather than let my Stocks and Shares ISA allowance go unused, if I had a spare £20,000 right now, this is how I would spend it buying shares I thought could set up passive income streams for the long term.

High income, growing income or both

As a long-term investor, I would be putting my ISA to work not just for now but also with an eye on the years ahead. So I would think about what my objective was when it came to income.

That may sound obvious – I would like lots of it! In reality though, there are a few more nuanced questions I might helpfully consider.

For example, although dividends are never guaranteed, would I prioritise jam today or jam tomorrow? Some dividends are large but flat – Jupiter is an example from my own portfolio. Others are much smaller but growing. For example, DCC has a yield of 3.6%, just a fraction of the 16.7% offered by Jupiter. But it has raised its dividend annually for well over two decades.

I might also consider whether I would be willing to invest in cyclical industries. These can offer high dividend yields in good years, but when commodity selling prices fall those often drop. For example, the 11% dividend yield of Rio Tinto looks attractive to me now. But if metal prices fall sharply, I expect the annual dividend will be cut deeply.

Investing in great companies

But yield is always just one part of the story. To sustain a payout, a company needs to generate enough extra income to fund it. For example, while the Jupiter yield right now looks eye-popping, its first half earnings did not cover it. If Jupiter cannot improve its business performance, I see a risk of a dividend cut.

That is why when looking to invest in my Stocks and Shares ISA I would try to find businesses I thought had a sustainable competitive advantage in a resilient market.

With £20,000, I could diversify my portfolio across five or even 10 such companies. Finding 10 great businesses I can understand that sell at an attractive share price today may be a challenge. So I would be willing to keep some or all of the money sitting in my ISA until I found income stocks that felt right for me. Remember, I am investing for the long term. Patience is critical to doing that successfully.

Reinvesting dividends in my Stocks and Shares ISA

As £20,000 is a substantial sum, hopefully it could earn me a decent amount in dividend income each year. At a 5% average yield, for example, my earnings could be £1,000 each year.

But rather than take them out, what if I simply left them in the ISA and compounded them? That could help me grow my future income streams even more – which is why I would do it.

If I hold my shares and keep reinvesting, hopefully I would be generating passive income for decades.

The post How I’d invest £20,000 in a Stocks and Shares ISA to generate extra income for life appeared first on The Motley Fool UK.

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C Ruane has positions in Jupiter Fund Management. The Motley Fool UK has recommended Jupiter Fund Management. 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.