My Stocks and Shares ISA is a great tool to allow me to take advantage of favourable tax treatment when investing. I’ve had an ISA for years, but if I was starting over with an empty one and trying to build up my passive income stream, here’s what I’d do and where I’d look to allocate my money.

My strategy

If I’m going to be focused purely on income generation, the bulk of the stocks I’d look to buy would be dividend shares. This refers to companies that pay out dividends on a regular basis, which provides me with cash which I can then either bank or reinvest to buy more stock.

I’d put 75% of my money in dividend shares. The other 25% I’d invest in growth stocks. These probably won’t pay me any income. However, they have the potential to offer me high share price appreciation in the coming years. For example, let’s say I invested £1,000 in a stock, with average share price gains of 10% a year. After the first year, I could trim my holdings in the company by £100 and still retain my original £1,000 investment. This can act as a source of income.

The main risk with dividend shares is that the income isn’t guaranteed. If a firm has a bad year, it might cut the payment. For growth stocks, the share price might fall instead of rally. This would mean I can’t pull any money out for that period of time.

Building the portfolio

One example of a stock that I’d include is Investec (LSE:INVP). I don’t currently own the stock, but am seriously thinking of buying it.

The current dividend yield is 5.85%, well above the FTSE 250 average. Over the past year, the share price is up 32%. So this could actually act as being a perfect mix of a dividend and growth stock!

The bank has performed well over the past year. Last month, it provided a trading update, which highlighted the “more positive economic outlook”. It expects adjusted operating profit to be between £520m and £550m for H2, in contrast with the £487.7m from H1. With adjusted earnings per share also projected to keep rising, I don’t see the current dividend under any threat.

Investec has a blend of operating divisions, ranging from wealth management to corporate banking. It has diversified geographic exposure, from South Africa to the UK. This should allow it to smooth out any individual problems in a specific area.

One risk is that the recent merger with Rathbones Group could act as a drag overall. Soundbites from past months indicate that the progress is very time-consuming.

The income potential

Each year, I can invest up to £20k of my money in the ISA and y gains are all tax-free. If I assume that I can afford to invest £1k a month in a portfolio that yields me 6.5% a year, my income potential could rise quickly.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

If I kept this up for 11 years, my pot could be worth £194,085. In the following year, this could then yield me £1,051 per month on average.