How an investor can use a Stocks and Shares ISA to target £1,120 in dividends a year

One of the attractions of investing with a Stocks and Shares ISA is the ability to collect tax-free dividend income. Here’s how an investor can use an ISA to target an annual dividend income of over £1,000.

Please note that tax treatment depends on the individual circumstances of each client and may change in the future. The content of this article is provided for informational purposes only. It is not intended to be, and does not constitute, any form of tax advice. Students are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.

Taking a smart-yet-simple approach to investing

An amount like £20K is enough to comfortably split, say, five to 10 shares. Rather than trying to find unknown growth stocks, I usually (not always) choose to stick with big, proven, blue-chip stocks.

A proven business model and willingness to use free cash flow to pay dividends can be a good indicator when it comes to establishing an income stream from an ISA.

So I think a smart investor would stick to companies they know in industries they understand.

By trying to buy when the big stocks look cheap and holding them for a long time, they can leave their Stocks and Shares ISA untouched for months and sometimes even years at a time while the income hopefully rolls in.

Time to think about asset allocation

There are different ways to diversify.

One would be not to invest more than, say, a quarter of an ISA in one industry, although some (such as tobacco and financial services) may be particularly tempting because of their high yields.

Starting with a target yield in mind can be a dangerous game as it can lead to the tail wagging the dog.

After all, no dividend is always guaranteed and sometimes a high yield is a sign that the City is expecting budget cuts – Vodafone (LSE: VOD) is a prominent example of the past year.

Instead, I think it makes sense to look at the potential long-term value of the share, compared to its current valuation.

Many options are possible in the current market

Right now, I think there are quite a few strong, proven blue-chip companies in the London market that are selling at attractive valuations and with yields of 5%, 6%, 7% and even up to 10% in some cases.

One example that I think investors should consider with their Stock and Shares ISA is, in fact,… Vodafone!

Why? Budget cuts may seem like bad news. But even after that, the call share will still offer a yield of around 5.6%.

Reducing the dividend also reduces some of the cash flow pressures on the company. That would allow it to pay down more debt, something it has been improving on in recent years, although I still see its total debt of around £27bn as a risk – servicing, let alone repaying, eats into profits.

The telecommunications market is huge and likely to remain so – and mobile money is a further growth path.

Vodafone has a large customer base and a strong brand. It is the market leader in many European and African markets and recently became the largest fiber supplier in Germany.

Setting realistic expectations

As I said, I see a few stocks worth considering FTSE 100 with a yield equal to Vodafone’s, or higher.

Sticking to that 5.6% as an average return across the portfolio, a £20K Stocks and Shares ISA would generate £1,120 in dividends each year.