Happy new tax year!
Well, I know what you are thinking, happy and tax should never be used in the same sentence! But in this case I can be forgiven for doing so. The start of the new tax year brings with it the opportunity to invest an amount up to £20,000 completely tax free using an Investment Savings Account. If that doesn’t get you excited, I don’t know what will!
The easiest way to describe an Investment Savings Account or an ISA for short is as a legalised tax heaven for the average person like you and I. When you invest via an ISA, you are able to earn dividends and capital gains completely tax free. In essence, you can use an ISA to build your wealth and keep it away from the tax man!
The big benefit of an ISA over another tax incentivised account such as a pension is that in an ISA, you are able to withdraw money at any time and without any tax charges– whereas in a pension you can only withdraw money after you reach 55 years of age and any withdrawals are taxed at your marginal rate of tax.
I have written previously on how to open an investment account (including an ISA) and the best places/platforms/websites to open those accounts so I will not touch on those topics here.
Why Do I Invest In an ISA Or Invest Any Money At All? What Will I Achieve At The End?
Investing is simply putting away some money today so that you can have more in the future. In essence, people invest so they can have more money in the future. Who doesn’t want more money?!
That is why I invest. So that I can have this giant pile of money so that I can retire when I choose to; not when I am too old to work and get pensioned off. So that I can be financially free!
When it comes to creating passive income from the stock market, there are two common methods. The first is to follow the 4% rule where you build a portfolio of a certain amount and you sell 4% of your portfolio every year in order to get the cash you need to cover your spending. The problem with this route is that you constantly have to sell stock in order to derive income. Furthermore, I don’t like to rely on market movements to provide me a steady stream of income. I have no clue what the stock market will do tomorrow, let alone in 10 years when I plan to have retired.
The other method, which I prefer, is via dividend income. Investing in companies that provide me with streams of cash at regular intervals. I never have to sell stock using this method. I can preserve my capital for life. Why cut down the tree when you can simply pick the fruit?
You see, a stock or share is simply an ownership stake in a business . I know the financial press has lead us to believe that stocks and shares move up and down at random and the stock market is a giant casino. But that is not the case. Behind every stock is a real business. Behind the KO stock ticker is the worlds preferred beverage drink maker Coca Cola, behind NKE is the worlds most famous athleisure brand Nike, behind SBUX is the worlds favourite coffee chain Starbucks and behind AAPL is the company that brought us the I-Pod and I-Phone, Apple.
And over the long term, the stock tickers move in the direction the underlying business is heading in. So if the underlying business is making more revenues and more profits, the stock price will follow and head higher over time. Just look at the AAPL stock price for an example of this. The stock went nowhere in the 1990’s and early 2000’s because the underlying business – Apple – was not very good. But the company started to innovate and released products such as the I-Phone and I-Pod which were massive hits and brought in record profits year after year. And looking at the APPL stock, you can see this as the stock really took off after the release of the I-Pod and got a further boost upwards after the success of the I-Phone. Over time, the stock followed the success of the underlying company.
And as the underlying business begins to earn more and more, they want to reward the shareholders, the people who own stock in the company. They can do so by declaring a dividend; paying the profits to these shareholders in proportion to their ownership stake in the business. So say company X wants to pay out a dividend of £100, if the only has 100 shares outstanding, than an owner of each share would be entitled to £1 in dividends. So if you own one share you will receive £1, if you own five shares you will receive £5, if you own 10 shares you will receive £10 and so on and so forth.
Going back to Apple, it declared a split adjusted dividend of $0.378 a share in 2012. But as the company kept earning record profits year after year, it wanted to reward shareholders with increasing dividends year after year. The dividend per share now stands at $0.82 – an increase of 116% over the years!
This is what dividend growth investing is all about. Companies you invest in paying you increased amounts of dividends year after year. And you can use these dividends as you please. For me it would be used to cover all my expenses. And because its purely passive and I don’t need to lift a figure to earn them, I could essentially retire if I wanted to. Its like having my own Universal Basic Income.
How Much Dividends Do I currently Receive In My Stocks And Shares ISA
I have been making use of ISAs for 5 years now and the dividends I receive in this account is currently just over £4,000 per annum and growing. I will be writing about crossing the £4,000 dividend income mark so be sure to keep an eye on the site for this.
It has been hard work but I can tell you it is worth it. Every time a dividend hits my account I keep thinking that I should have started investing sooner. But I am happy with where I am today. Have a read of how I made my first £1,000 in annual dividend income to see how I got my start – the stocks I bought and how much they pay me each and every year.
By investing in high quality blue chip companies, the £4,000+ I currently receive in dividends each year is a good building block. The aim is for me to cross £5,000 this time next year. I have a couple of stocks such as BT which have paused their dividends this year so it will give my passive income a nice little jolt upwards when they resume.
£4,000 may seem like a small amount after four years. My first dividend payment from BP was only £36. I could have stopped right there and then. I could have asked myself what’s the point. I could have questioned how a measly £36 a year could make a difference to my life. But I didn’t. I persevered. I knew that even that everyone starts small. Even the best investors and richest people had humble beginnings. Tomorrow’s giant oak trees and planted by the small seedlings of today. And that’s the nature of dividend growth investing. The initial phase is slow but there are rapid increases later on. Just look at my post titled Saving Is More Important Than Investing Early On.
I am proof of this. Every £500 milestone I reached has been faster than the last. This is due to the trifecta of new capital infusion, organic dividend growth and dividend reinvestment.
One thing I have learnt during this process is that money starts to work for you pretty quickly. Money works harder than anyone I know. It works incredibly hard. Harder than you or I could ever work. It requires no sleep or food. Better yet, it works harder and harder as time goes by. That’s because it replicates itself, creating extra little worker bees all by itself. And those new worker bees later create more new worker bees. On and on it goes.
Looking at my end goal of having my dividend income cover all my expenses, I am slowly getting there. The amount I currently receive would cover my annual rent bill. I do not have to worry where the money will come from to pay my landlord. How cool is that! And the more I invest, the more my dividends grows organically, the more expenses I will be able to cover!
How I Plan on Increasing My Dividends Over The Next Year
There are three main ways I plan on Increasing my dividends over the next year.
1. Buying Shares In Quality Companies – The first and obvious way is to buy more shares using the fresh £20,000 allowance I am entitled to. If I had to invest the full £20,000 in a share offering a 5% yield, I could add a cool £1,000 in dividends a year to my portfolio. Now I won’t be saving the full £20,000 a year due to competing priorities such as a house purchase but I know that every little penny I sock away in my ISA will compound over the years and add to my dividend income.
2. Dividend Increases. One of the biggest areas of potential dividend growth over the next year comes from potential dividend increases. This is the advantage of buying into high quality shares. The more profits a business makes, the more they are likely to send my way in dividends. Just look at company like Procter & Gamble which has grown its dividend for 63 years straight! During this period there has been multiple recessions, including the worst meltdown since the Great Depression, the dot-com bubble and the housing bubble, the Asian financial crises, multiple international wars, ballooning government deficits, exploding national debt, countless natural disasters, political earthquakes and a maelstrom of regulatory changes in the financial industry, and Procter and Gamble still managed to increase their dividends during each of those years. This is truly amazing and that is why I aim to invest in quality companies like Procter & Gamble.
3. Reinvesting Dividends – By using the cashflow produced by dividend stocks, I can buy into even more dividend paying stocks. In essence, this ISA tax year, I will have investable cash of £24,088 as opposed to the standard £20,000 due to the £4,088 in dividend income I am expected to receive. And that number will only grow with more purchases, dividend increases and dividend reinvestments. Its a vicious cycle working in my favour.
I did a post titled my dividends are producing more dividends. This post is definitely worth a read. And if you have read it before, it is definitely worth re read.
Six years on since I started documenting my investment journey, my portfolio has so far thrown off dividends worth over £12,500. Whilst I could have taken these dividends and spent them as I please, I decide to reinvest them in order to get even more dividends going forward. Going by my average portfolio yield of 4% my £12,500 worth of dividends have essentially added £500 in annual dividend income. And as the years go, this figure will only get bigger. That is why I will continue to re-invest dividends in this manner until a time when my dividend income will cover all my living expenses after which I will draw on my dividends for income. A time I can say I am financially free.