How I’m using big-payout dividend stocks to target early retirement

I’m aiming to retire in middle age, not old age, and lucrative dividend stocks are my key to a comfortable future. Here’s how I use them.

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In my life in the City, I sometimes heard traders say they had no time for dividend stocks: they were only interested in the speculative punts, the “double or quits” penny shares. A couple of them made it big, but most lost their shirts.

There is no need to take big risks on the stock market. An investor can make serious money by investing in a handful of very good stocks that steadily increase in value over time and pay out large dividends without fail.  

Indeed, this is the Warren Buffett way. It’s tried and tested.

Dividend stocks yielding 7% are my target

£1,000 in cash receiving 7% interest a year would double to £2,000 in 10 years. This sounds good, but even with interest rates on the rise, depositors are lucky to get 1.5% interest on cash in the bank at the moment.

However, there are some high-paying FTSE 100 dividend stocks yielding 7% or more that potentially offer excellent returns. It’s these that I am targeting.

This is because if these companies are also increasing their profits year on year then it’s likely the dividend and share price will increase, too. This is the perfect combination!

My initial £1,000 would then grow at a higher rate than the 7% and I would double my money long before 10 years are up.

Compounding

But there’s more. If you reinvest the dividends in additional shares in the same company, which then continue to grow, then you make even more money. This is compounding. Again, Warren Buffett swears by this.

I have been doing it with Legal & General sharesfor example, which I initially bought after the market crashed in 2020 due to the Covid-19 outbreak. The shares have been a lucrative investment.

Furthermore, some companies make so much cash they dish out “special dividends”, i.e an additional payout. I will often reinvest those in the same company, too.

I am considering buying more shares in Barratt Developments, which has a dividend yield of nearly 7% and £1.1bn in cash on its balance sheet. Some analysts have predicted this cash could be paid out as a special dividend.

A risk with the high dividend-yielding housebuilding stocks is that higher interest rates and the cost-of-living crisis eventually deter prospective house buyers.

However, there is a shortage of new homes and demand is still high in the UK. These stocks are worth watching for buying opportunities on share price dips.

A notorious pitfall

One risk to the high dividend strategy is being drawn into what’s called a “value trap”. These are shares that offer a high dividend and look enticing, but the company has basically stopped growing. The dividend never increases and sometimes gets cut. The share price then falls. You lose money.

Vodafone is one example of this over the last few years, and fortunately it is the only mistake I have made with this strategy. One learns by experience.

Sometimes a takeover or good merger can get an investor out of a hole, however, and I will see what transpires with Vodafone.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Michael Wood-Wilson owns shares in Legal & General, Barratt Developments and Vodafone. The Motley Fool UK has recommended Vodafone. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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