How I’d invest a £20K ISA to target £1,000 in annual passive income

Many investors want to generate passive income in retirement, but making this work requires active involvement.

I want to fund my retirement by investing in individual stocks FTSE 100 stocks, instead of slapping money into a tracker fund and then sitting back. I think I can generate a higher rate of income by actively building a diversified portfolio of stocks instead of buying the entire index at once.

Time to get active

This is a bit risky, but with luck my stock picking strategy should yield higher profits. This is because I can target FTSE 100 companies that I think will go further in achieving my investment objectives.

So instead of getting the current FTSE 100 average yield of 3.53%, I can aim for 5% or 6%. This will make a big difference to your total return over time.

If I have £20,000 to invest in a Stocks and Shares ISA and am targeting an annual income of £1,000 in year one, I need a return of 5%.

Many FTSE 100 dividend stocks already pay more than that. mining giant Rio Tinto, for example, currently yields 9.71%. If I invest £20,000 into a single stock, I will earn £1,820 a year.

That would be risky, though. Dividend payments are not guaranteed. They can be cut at any time. While Rio looks safe now, because it is guaranteed 1.7 times by earnings, going all-in on one stock is far too risky for me.

I can balance it with smaller and safer dividends, for example from pharmaceutical companies GSK. It currently yields 3%, which is below the target of 5%, but the payout is covered 3.2 times by earnings, leaving room for improvement. Next year, GSK is predicted to return 3.8%. Even better.

Some great products are out there

Tobacco stocks pay some of the most solid dividends. For example, British American Tobacco‘s yield is 7%, guaranteed 1.7 times by earnings, while Imperial brand yield 6.98%, guaranteed 1.9 times.

Tesco (4.43%), National Grid (4.98%), SSE (4.96%), BT Group (5.57%), and Aviva (6.55%) all pepper target yield 5%, and will help me hit the passive income goal. Other stocks will help me, especially Barratt’s Development (8.02%), The Vodafone Group (8.16%), and M&G (9.14%).

I have to do my due diligence to make sure that these stocks will continue to generate the income streams needed to make a steady dividend. Each company has its own risks, as well as potential rewards, but the ones I’ve listed here seem to be good choices for your Stocks and Shares ISA portfolio.

5% passive income target for first year only. The average yield of my portfolio has been increasing over time, as companies raise their dividends and I reinvest to buy more stocks.

Retirement is 15 years away. With any luck, a £20,000 ISA investment should be much more, and give you a passive income of over £1,000 a year.