Today I have a guest post for you from my fellow money blogger Lewys Lew, who blogs at The Frugal Student.
Lewys has a particular interest in dividend investment. As I know this is a subject of interest to many readers of this blog, I asked him to write about it here.
Over to Lewys, then…
I watched the Conservative party conference in despair!
Not because I’m a Conservative but because once again the vultures circle Theresa May and Brexit seems to be going backwards.
Not that I voted to leave, but this constant uncertainty unsettles me and the market.
To add a cherry on top of bad news, productivity in the UK has begun shrinking and we’re no better off than we were in 2007.
What this means for you and me is that the economy continues to struggle and along with that interest rates remain dire.
Sure, for those of us who save a few pounds a month there are some decent bank accounts out there that offer 2%+ interest but these usually come straddled with a set of conditions and maximum deposits.
For those with large sums lying dormant in bank accounts the deals on offer are pitiful. With the current rate of inflation, your cash-pile may even be worth less.
In this post, I’m going to share with you how you could earn 5% in interest yearly.
Before we begin, there are a few things to note:
- If you use this method your money is at risk.
- To reduce risk, you should be prepared to lock your money up for 5+ years.
- This method may not be suitable if you’ll need to use this money in an emergency
(remember to always keep six months’ worth of expenditure in an easy-access account)
- Here’s some key terminology before we start:
Dividend = Money a company pays to you as a reward for being a share-holder.
Dividend Yield/Yield = A dividend as a percentage of a current share price, as so:
Dividend per share/Price per share.
Right, let’s get stuck in!
Dividend investing is a vast field. Myself, I’m a dividend growth investor. At 24 years old, I seek to buy stakes in companies who are growing their dividend at a rapid pace. Over time these types of stocks often increase their dividends at higher rates than companies who already pay a dividend at a higher yield.
But for those who maybe don’t have the benefit of a 30-year investment horizon, dividend yield investing may be a better choice for you. Frankly, getting just 1% of invested monies back as a dividend each year isn’t going to satisfy you if you’re close to retirement or retired.
The good news is that there’s an alternative dividend investing method that could see you getting 5% of your invested monies back each year, along with some capital gains along the way.
I’ll illustrate dividend yield investing with this example…
National Grid is a very boring, steadily performing utility company. It owns and manages the UK’s grid structure along with some bits in the United States and in return is allowed to make a modest profit from its operations. It’s a monopoly, meaning that we don’t need to worry about competition or anything of that sort.
As we can see from the graphic below (from the Hargeaves Lansdown website), National Grid pays a 5.15% dividend. This effectively means that for every £100 you invest, you’ll get £5.15 back every year.
The good news is that National Grid buys back its own shares, pushing up the capital value of your holding and reducing the possibility of capital loss over the long term (5+ years).
Dividend investing can be especially powerful if you use your dividends to buy more shares.
£1,000 worth of National Grid shares would let you buy around 5 additional shares with the dividend after one year. Compound this over the years and you could really start building a decent stream of dividend income.
Pros and Cons of High Yield Investing
- When dividend yields go over 6%, this can be an indication that the stock is risky, as investors are fleeing the stock, thus reducing the share price and increasing the dividend yield (as this is relative to the price).
- Stock prices could fall below your original purchase price and dividend income combined, leading to a net loss.
- A large capital deposit is needed to make this method really effective; small amounts won’t really go a long way.
- You have to pay to buy/sell stocks.
- Identifying safe higher yield stocks can be difficult and time-consuming.
- A 5+% dividend yield smashes any bank account out there.
- The combination of steady stock price rises and dividend income can really boost your savings.
- Large and ‘boring’ companies such as National Grid are very resilient and it’s relatively unlikely that you’d find yourself at a capital loss if you held such stocks over five years.
- Remember that other investments can carry large risks and costs too. One such example is buying a rental property, where bad tenants, maintenance costs and the hassle can eat away at returns. By investing in a large company you won’t need to do anything else. Just sit back and soak up the dividends!
How Do I Buy Shares?
If you’re interested in building yourself a dividend income later on in life (40+) then I would certainly recommend chasing higher yields from boring large companies such as National Grid.
In order to buy shares you’ll have to sign up with a broker.
The most popular in the UK is Hargreaves Lansdown, but this platform charges a management fee of 0.45% annually, in the case of National Grid lowering your net income from 5.15% to 4.7%. They also charge £11.95 for share repurchases and 1% for dividend reinvestment.
To really reap the benefits of this strategy, I’d recommend signing up with online brokers De Giro, who only charge £1.75 a trade with no management fee.
If you like the idea of dividend yield investing but the risk is a little too high for you, I recommend you take a look at my Nutmeg Investment Review for a platform that manages your portfolio for you.
Many thanks to Lewys (pictured, right) for an eye-opening article.
Personally I have tended to stick with self-selected funds and ready-made portfolios (including Nutmeg) for my core investments, but I can certainly see the attraction of high-yield share dividend investing for part of my portfolio – especially as (being semi-retired) I am now looking to generate an income from my savings.
Another thing in favour of dividend yield investing is that there is a generous annual tax-free dividend allowance (which most people don’t make use of). Currently you can earn up to £5000 a year in dividends before any tax is due. The government has threatened to reduce this to £2000, but even if that happens the allowance is still well worth taking advantage of, as it comes in addition to other tax-free saving and investment opportunities such as ISAs.
If you have any comments or questions about this post, as always, please do leave them below.