Image source: Getty Images
Got spare money but no ideas for how to put it to work? Parking it in a Stocks and Shares ISA this week before the annual contribution deadline would allow it to be used later on as you chose. One option would be to try and build passive income streams, by using the ISA to purchase dividend shares.
That is possible but there are some potential pitfalls to avoid. Here are three things that could help you build stronger passive income streams from your ISA
1. Choose the best ISA
It might sound obvious, but a good place to start is by getting the most from your ISA supplier, while keeping costs to a minimum.
Fees, commissions, and charges might sound small. But a 0.3% here and 0.5% there, £50 fixed commission here or £15 minimum there can soon start adding up. That can eat into returns over the long term.
So I think it makes sense to shop around when choosing the right Stocks and Shares ISA.
2. Focus on the quality of the dividend, not just its current yield
I like a high yield as much as the next investor. When investing I do look at a share’s yield.
But, critically, I do not look only at that.
I consider a number of other factors that help me judge what I think the dividend’s quality is.
For example, how well covered is it by free cash flows? How does the company’s board of directors prioritise dividend payments among other capital allocation choices? What might the balance sheet mean for free cash flows in future? How sustainable do the company’s cash flows look?
These are all subjective judgements to some extent. But I still think they are important when considering how long a dividend might last and what could happen to it in future.
3. Let the dividends earn dividends
Another way to boost passive income streams over time is to reinvest them, rather than taking them out as cash.
That way, the dividends themselves can start earning dividends.
This is known as compounding. It is a simple but powerful tool when it comes to growing passive income streams.
One income share to consider
Let me go back to what I said above about a company being able to sustain its dividend.
British American Tobacco (LSE: BATS) has a sizable debt pile. Its target market of cigarette smokers is shrinking, while regulatory burdens continue to threaten sales.
That makes it sound like it may be tough for the FTSE 100 owner of brands including Pall Mall to maintain its dividend over the long run, let alone keep growing it annually as it has done for decades.
But the company has strong pricing power, thanks to nicotine’s addictiveness and its portfolio of premium brands.
Cigarette demand has been in decline for years already in many markets, yet the company remains highly cash generative. It has also been growing its non-cigarette business.
Not everyone wants to be involved with tobacco companies, given the ethical questions concerned. But for those who do, I think British American Tobacco merits consideration given its passive income potential.
