UK stocks have experienced a mixed 2022. Resource and energy stocks have surged. But the reality is that many UK-listed stocks are currently trading at a discount.
And while this stock market correction hasn’t been kind to many investors, it does create opportunities.
So, let’s take a look at why I think investing now is good idea, and how I’d look to generate a second income source by investing £5,000 in UK stocks paying dividends.
Why invest now
As a long-term investor, I shouldn’t be too worried about fluctuations in share prices. After all, the general trend of markets is upwards — in fact, the FTSE 100 is approximately four times larger today than it was 30 years ago.
However, we all want to find the best entry point. And by buying when stocks are low, I can reduce the risks of losing money and help propel my portfolio forward when the market recovers.
However, it’s worth noting that some stocks are discounted for a reason. I’ve really got to do my research to work out which companies are meaningfully undervalued.
But there’s another reason why I’m investing now. When shares prices go down, and dividend payments remain the same, the dividend yield goes upwards.
And the dividend yield is always relevant to the price I pay for the stock. So, if the share price goes up after I’ve bought the stock, it won’t make a different to the yield I receive.
Compound returns
If I invested £5,000 today in stocks paying a handsome 8% yield on average — including Phoenix Group, Direct Line, and Close Brothers Group — I’d receive £400 at the end of year one.
That’s fine, but it’s not really life changing. If I reinvested my dividends every year for a decade, at the end of the decade, I’d have £10,500. In turn this would provide me with just over £800 a year in dividends.
And if I reinvested for 30 years, at the end of the period I’d have £55,000. This would give me £4,500 a year in dividends.
These calculations aren’t perfect as they don’t take into account share price growth or changes in the dividend. But, by applying a compound returns strategy, it’s clear that I can turn £5,000 into a second income source.
Naturally, consistent investment in my portfolio over the period would help me grow my capacity to generate additional income. After all, the more I put in, the more I can hopefully take out.
Sensible choices
Sensible choices are vital in a compound returns strategy. I need to be wary of big dividend yields as they are often unsustainable. Instead, I need to do my research, starting with the dividend coverage.
A dividend coverage ratio above two is particularly healthy and a sign that the company shouldn’t have any problems paying its shareholders.
