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One way to try and earn a passive income is to stuff your ISA full of dividend shares.
To demonstrate how that could work in practice, I will explain how someone could target an average weekly passive income of £250. That adds up to £13k a year.
Setting up the ISA
The first step, of course, is having an ISA!
There are lots of different options when it comes to choosing one. Some people like higher levels of service than others and each investor is different.
In each case, one of the things I always look at is what it is going to cost me. Costs will eat into the size of my ISA and therefore its dividend generation potential.
That could come in the form of set-up costs. But there are lots of other potential fees and charges: administration costs, dealing commissions, annual fees, and more. What seems like a small percentage can add up to a large sum of money over the long term.
So choosing the right Stocks and Shares ISA is important.
The mechanics of passive income
With a £13k annual target, a 10% dividend yield would require an ISA worth £130k. A 5% yield would need a £260k ISA.
While 10% seems very aggressive to me as a target at a time when the FTSE 100 yields around a third of that, I think around 7% is a realistic target in today’s market even while sticking to blue-chip shares.
That would require an ISA of around £186k.
That could be a lump sum, but it would also be possible for an investor to put £20k per year into their ISA and hit that target within 8 years by compounding at 7% annually.
A smaller regular contribution would work too, though it would then take longer to hit the target ISA size.
One dividend share to consider
One share I think investors should consider for their ISA is paper and packaging group Mondi (LSE: MNDI).
The past few years have been uneven ones in the packaging industry, with demand swings impacting pricing. That has taken its toll on the Mondi share price, which is down by more than half over the past five years.
Dividend yield is a function of dividend per share and share price. So Mondi’s falling share price has pushed its yield up to 7.5%.
Of course, dividends are never guaranteed to last and that is true for Mondi’s, just like any other company. I see a risk that ongoing soft pricing in some parts of the packaging market will continue to weigh on profitability.
However, over the long term I expect packaging demand to stay high, even if it does move around.
The barriers to entry in the industry are fairly high given the cost and complexity of building large factories and matching them up to suitable supply chains and end markets. Mondi’s substantial global footprint gives it economies of scale.
