Here’s how to invest £20,000 in an ISA for a 7% dividend yield

UK income stocks typically offer a dividend yield of around 4%, on average. But some businesses are leading the way FTSE 100 offer more. And while not every high yield is sustainable, some can expand an investor’s passive income stream.

With that in mind, and the end date of the Stocks and Shares ISA, how can an investor build a 7% income portfolio in 2023?

1. Don’t just focus on dividend yield

As strange as it sounds, only looking at companies that offer 7% yield, or more, can quickly lead investors astray. And it also creates an opportunity cost. In addition to having a short list of options, there may be greater long-term income opportunities. Just because the business has paid less today does not mean that it is not possible to grow in the future.

Therefore, priority should be given to finding income stocks that generate excess free cash flow. Don’t forget dividends are just a way for companies to generate extra capital for their shareholders. But that can only happen if there is extra money in the first place.

Companies that can maintain and grow their cash flow organically are the hallmarks of Dividend Aristocrat. This is a company that has increased shareholder payouts for more than 25 consecutive years. And investing early in this journey can pay huge dividends in the long run.

Just look at Warren Buffett’s initial investment Coca Cola in 1988. After 35 years of dividend increases, the yield on the original cost basis is now 56.7%!

2. Diversification

Investing £20,000 with a Stocks and Shares ISA is more than enough capital to build a diversified portfolio. Buying shares in many businesses operating in different industries is most important. Why? Because even the largest companies are vulnerable to disruption in the short and long term.

Look at the 2020 pandemic as an example. Before Covid-19, many travel stocks offered shareholders a steady stream of income. But after the virus ravaged the world, those dividends quickly dried up. And most are still struggling three years later to return to their former glory.

The impact of these disruptions can be mitigated by ensuring the portfolio is not concentrated in a single sector. In other words, diversification protects portfolio returns.

A FTSE 100 stock that returned +7%?

By combining high and low dividend yielding companies, investors can easily reach their target income of 7%. So let’s take a look at the FTSE 100 stocks that offered the most in March. But remember, investors should investigate each one thoroughly to verify that the payments are sustainable or, better yet, can be expanded.