How I’d invest £20,000 in a Stocks and Shares ISA to earn passive income for life
Investing in the stock market can be a great way to make money. Done well, owning shares can provide a stream of passive income that lasts a lifetime.
As a UK investor, I aim to take advantage of my Stocks and Shares ISA allowance. This lets me invest up to £20,000 without paying tax on the money I make.
The stock market
One way to earn extra income is by starting a business. If I wanted to set up a drinks company, for example, I could come up with a recipe, buy ingredients, make the product, and sell it.
That’s a lot of work, though. It’s also expensive and there’s some tough competition from the likes of Coca-Cola, Diageo, and Fevertree Drinks.
The stock market gives me a way around all of this. Instead of having to set up by myself, I could buy shares in a company that is already established.
With as little as £1, I could own a portion of one of the major drinks businesses. This includes their manufacturing equipment, distribution network, and brand names.
Best of all, I’d own a share of their earnings. Rather than trying to beat big businesses at their own game, I’d sooner join them as a shareholder.
Getting paid
There are two ways that a business can return cash to its owners. One is by dividends and the other is by share buybacks.
Dividends involve a company distributing its earnings directly to its shareholders. Each share gets paid a certain amount.
Paying a dividend is how I’d take money out of a company if I owned the whole thing. Alternatively, a company can choose to use its cash to repurchase its own shares. As a result, the total number of shares goes down. This allows investors to generate extra income by selling part of their investment without reducing their overall stake in the business.
If I owned 1% of Diageo and the company repurchased 3% of its shares, I’d be able to sell 3% of my investment while still owning 1% of the business. My profits would be passive income.
Passive investing
Dividends and buybacks are never guaranteed. A business might decide it has a better use for the cash.
There are a few things that investors can do to avoid a nasty surprise here, though. The most important, in my view, is understanding the company’s overall strategy.
Some businesses aim to use their cash for growth. This type of enterprise is more likely to reinvest its cash internally than to distribute it to shareholders.
There’s nothing wrong with that. But a company that is investing heavily for growth is unlikely to generate significant passive income in the near future.
Other businesses either don’t have opportunities for growth, or don’t need to reinvest their profits to grow. These are the kind of investments I’d target for lifelong passive income.
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.
The post How I’d invest £20,000 in a Stocks and Shares ISA to earn passive income for life appeared first on The Motley Fool UK.
Pound coins for sale — 51 pence?
This seems ridiculous, but we almost never see shares looking this cheap. Yet this recent ‘Best Buy Now’ has a price/book ratio of 0.51. In plain English, this means that investors effectively get in on a business that holds £1 of assets for every 51p they invest!
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More reading
- With no savings at 20, I’d buy these UK stocks to hold until retirement
- I bought these 4 US growth stocks for a tech recovery
- Is now a good time to buy FTSE 100 shares?
- How I’m building a new second income for 2023
- I’m listening to Warren Buffett and loading up on cheap shares
Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Diageo Plc and Fevertree Drinks 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.
