2020 has thrown up a lot of different scenarios for investors to react to. Volatility in the FTSE 100 has increased, interest rates have been slashed, and future corporate earnings have been downgraded. One impact of this is lower dividend yields. With many firms struggling with cash flow due to the pandemic, keeping cash within the business is key. Therefore paying it out as a dividend to investors becomes unattractive in the short term. There are a few FTSE 100 dividend stocks that have kept paying out, and it’s these stocks that I’d be targeting to buy over alternatives.
Cash ISA alternative
The main alternative I’m comparing FTSE 100 dividend stocks to is a Cash ISA. This is because both options have the aim of generating income for the investor. It’s fairly easy to compare the two as well, based on the same investment amount.
A Cash ISA is an investment tool designed to preserve your initial investment amount and provide you interest. It’s essentially a high interest rate savings account that can be flexible or have a certain lock-up period. At the moment, NS&I has the best rate with 0.9%. So now we know the barometer to compare dividend yields.
FTSE 100 dividend stocks
There’s a couple of ways to look at the dividend yield for stocks. Firstly, you can take the overall FTSE 100 average. This sits at 3.65% currently. If you wanted to play it safe, you could buy a dividend fund that owns all 100 stocks and pays out (or accumulates) this 3.65% for you. Or if you wanted, you could buy individual stocks within the index that pay a higher (or lower) yield.
For example, Smith & Nephew is a medical equipment manufacturer. I’d classify the firm as fairly low risk, in that the products it makes is within a sector (healthcare) that will always have demand. The dividend yield sits at 1.85%, which is below the average, but it’s a safe dividend. If you’re simply looking to beat the Cash ISA rate, then there’s nothing wrong with buying Smith & Nephew. Added to this is the potential growth from the share price. Since the stock market crash in March, the share price is up 34%.
In contrast, you could invest in Legal & General. The financial services provider has a high dividend yield of 7.79%. The pandemic has negatively impacted profits, but the call was taken to pay out the dividend. You might conclude that this FTSE 100 dividend stock is higher risk than Smith & Nephew. This may be true – but remember you’re being compensated for this risk by the much higher yield.
Stocks trump cash
For me, buying dividend stocks over a Cash ISA makes sense. Primarily, you’re going to be picking up a higher yield. Added to this is the flexibility you have to change your yield depending on your risk tolerance. And, you also have the potential to make gains on the share price.
There’s a time and place for a Cash ISA, and so I don’t discount it completely for an investor. But when you compare it to dividend-paying stocks, I know which one I’d choose!
