20% increase with a 10% return? A top choice to consider for a stocks and shares ISA

Buying shares in companies that pay regular dividends has long been a popular strategy for British residents looking to build wealth and generate passive income. I think one of the most effective ways to do this is through a Stocks and Shares ISA – an investment account that allows UK residents to invest up to £20,000 per year tax-free.

Please note that tax treatment depends on each customer’s individual circumstances and may be subject to change in the future. The content of this article is for informational purposes only. It is not intended to be, nor does it constitute, any form of tax advice. Readers are responsible for conducting their own due diligence and obtaining professional advice before making any investment decisions.

It’s no secret that I’m a big fan of investing in dividend stocks, but most of my friends prefer to focus on growth stocks. Why? Some believe that a company’s focus on rapid growth in a shorter period of time could yield greater returns.

While that may be true, I’m more focused on the long game.

Why I think dividends are good for long-term wealth

One of the main benefits of investing in dividend stocks is the stable income they can provide. Although dividends are not guaranteed, I find that returns tend to be more reliable. This becomes even clearer when we look at the power of compound returns. When dividends are reinvested in the same stocks, they can generate additional income, which can in turn be reinvested, creating a snowball effect. Over time, this commingling can lead to significant wealth accumulation.

Take, for example, an investment of £10,000 in a portfolio of dividend-paying companies. Assuming an average annual return of 9% (including dividends), the investment could grow to around £60,000 after twenty years. This would pay out around £5,000 per year in dividends. After retirement, in addition to dividends, I was able to withdraw £6,000 a year for ten years.

Of course, investing more money for longer can increase returns exponentially, although I have to remember that profits are not guaranteed.

One of my favorites

One dividend payer whose opportunity I like right now is an insurance company Phoenix group (LSE:PHNX). It is a major player in the British insurance game, operating the likes of SunLife and Standard Life. Britain’s aging population is creating growing demand for retirement savings and income solutions, which could help boost profits.

But it’s not all plain sailing.

If the economy enters dire straits again, higher claims and lower investment returns could harm the group’s financial performance. Not only that, the insurance industry is heavily regulated. Regulatory changes could impact Phoenix Group’s operations and profitability.

In terms of performance, things are a bit disappointing. It has fallen by 25% in the past five years. However, thanks to a recent growth spurt, the sector has risen 20% in the past year. If the improving economy can help the country maintain that performance, it could become one of my top income earners by 2025.

The country is also in a relatively good financial position, with £9.6 billion in cash reserves and just £3.7 billion in debt. For comparison, fellow insurer Legal & General has £28.3 billion in debt and just £15.8 billion in cash. Although it reported losses in its latest earnings report, it has a low price-to-sales ratio (P/S) of 0.2. This indicates that the price is cheap compared to the revenue.

With a 10% yield and a history of paying consistent dividends, I found it to be a very attractive option for my income-oriented portfolio. Since 2010, annual dividends have risen from 31.8p per share to 56.5p, representing an average growth of 2.78% per year.