Here’s how a £20k ISA could earn £1,400 in passive income next year – and every year

Rather than setting up a side hustle to try and generate a second income, some people take the approach of making money from a business that is already well-established – and that they do not have to do any work for. Stuffing a Stocks and Shares ISA full of dividend shares in blue-chip FTSE 100 firms is one way to do that.

It can be quite lucrative too. Here is how a £20k ISA could earn £1,400 in passive income annually.

Setting a passive income target

The £1,400 number is easy to figure out. It is based on an average dividend yield of 7%.

Dividend yield is the amount an investor receives in dividends each year from some shares, expressed as a percentage of what they paid for them.

Seven percent is almost double the current FTSE 100 average yield. But I think it is achievable in today’s market while sticking to carefully-chosen blue-chip shares.

How dividends work

Dividends are never guaranteed – even if a company has paid them in the past, it can stop doing so at any moment. So it is important to choose carefully when selecting what shares to buy.

As well as that, an investor can reduce risk by diversifying across different shares. Twenty grand is ample for that.

Hunting for shares to buy

Given that no dividend is guaranteed, how might investors go about finding shares to buy for their ISA?

To pay dividends over the long run, a business needs to generate more free cash flow than it requires for its business. So when passive income is my goal, I tend to look for a proven business with high cash generation capability and limited investment needs to grow or even maintain the business.

One dividend share I think investors should consider is FTSE 100 insurer Aviva (LSE: AV). It was already the country’s largest insurer even before last week’s completion of its takeover of rival Direct Line.

That ought to add still more economies of scale to the business, as well as a famous brand. But I see a risk that integrating Direct Line could distract management attention from other tasks to keep the core business humming.

Insurance is pretty straightforward in principle, but the devil is in the details. Aviva has deep underwriting experience and is focused on general insurance lines in markets it understands well. From a risk management perspective, that appeals to me.

I also see appeal in the dividend yield. Aviva has been growing its dividend per share annually of late and currently yields 5.8%.

Choosing the right ISA

Striking the right balance between reward and risk is important.

Something else that affects the return an investor can make is how much of their dividend income gets swallowed up in fees, commissions, taxes and other charges.

Each investor has their own financial priorities. So it makes sense to spend time comparing different Stocks and Shares ISAs on the market when deciding which one seems most suited to their individual needs.

The post Here’s how a £20k ISA could earn £1,400 in passive income next year – and every year appeared first on The Motley Fool UK.

More reading

• Prediction: in 12 months the eye-popping Aviva share price could turn £10,000 into…
• £20,000 in an ISA? Here’s how it could be used to target passive income of £775 each month
• 3 big issues for buyers of FTSE 100 dividend shares
• I bought 1,256 Aviva shares 3 years ago. Here’s how much dividend and price profit I’ve made since then…
• These high-yielding FTSE 100 dividend shares are soaring! Time to buy more?

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.