I am investing in my Stocks and Shares ISA to generate a passive income. This product has some highly desirable qualities, making it the perfect vehicle to hold income stocks.
Any income or capital gains earned on assets held within a Stocks and Shares ISA is not subject to tax. That is not the case for assets held outside one of these wrappers. If I owned income stocks outside of an ISA, I would have to pay a dividend tax of 7.5% on any income over £2,000 a year.
As such, I try to keep all of my income investments inside an ISA.
Investing for passive income
When it comes to investing for income, I have two different strategies. First of all, I focus on high-quality dividend stocks. When I say high-quality dividend stocks, I do not mean I am looking for companies with the highest yields on the market. Instead, I am looking for businesses with the most sustainable payouts. The level of the yield does not particularly bother me, as long as it is sustainable.
A couple of examples of the sorts of companies I would buy to fit into this bucket include Diageo and Reckitt. These corporations have fat profit margins, which provide plenty of cash flow to support their dividends.
I would also buy financial services group CMC Markets. This firm has a cash-rich balance sheet and attractive economies of scale, which have enabled it to grab market share in the CFD and spread betting markets.
The big challenge I face with picking individual equities is that this strategy can be pretty risky. I could end up buying a company with terminal issues that only become apparent when it is too late. Therefore, I combine this single stock strategy with a diversified approach.
Funds for a Stocks and Shares ISA
As well as buying individual equities for my passive income portfolio, I also buy diversified investment funds. Some examples of the funds I already own and would buy more include the Law Debenture Trust and Murray Income Trust.
Both of these organisations have unique qualities which enhance their income credentials. Law Debenture is a financial services company combined with an investment trust. This gives the enterprise a diversified income stream to fund its dividends to investors. Meanwhile, Murray writes call options on equities it already owns to generate extra income.
Combined with the trusts’ income portfolios, I think these different approaches make these stocks the perfect investments for my passive income portfolio. However, due to their focus on income stocks, these may underperform the broader market as they do not have much exposure to growth equities.
Still, I am comfortable with the approach of these trusts. I would be happy to combine them with the high-quality income stocks outlined above for an income portfolio.
Rupert Hargreaves owns shares of Diageo, Law Debenture Corp., Murray Income Trust, and Reckitt plc. The Motley Fool UK has recommended Diageo and Reckitt 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.
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