Income stocks are well represented within my portfolio. Essentially, these reward their shareholders with regular, but not guaranteed, dividend payments.
By investing in these income stocks, I can either use the dividends to fund my life, or I can reinvest them.
The latter option allows me to benefit from something called compound returns. This is essentially the process of earning interest on my interest.
So let’s see how it works and which stocks I’d pick.
Mega-returns
Essentially, the compound returns strategy is very much like a snowball effect. The longer I leave it, the more money I’ll have in the end.
So if I were to start with £5,000 and invest in stocks paying a sizeable, yet achievable 7% dividend yield, after 20 years I’d have £20,000. After 35 years I’d have £57,000.
I could increase this final figure by drip-feeding cash over time, which makes a huge difference.
If I were to add £150 every month for 35 years, at the end I’d have £327,000. If I increase my monthly contribution by 5% a year, I’d have £560,000 after 35 years.
That’s the power of compounding and drip-feeding.
It’s important to note that the above calculation doesn’t allow for any share price gains. But it’s also important to note that gains aren’t guaranteed and I could lose money as well as make it.
Stock picks
I don’t want to put all my eggs in one basket. But with £5,000 to invest, I wouldn’t split it more than three ways. That’s because I may struggle to keep up with the stock research and the developments if I were to spread myself too wide.
So what three stocks would I pick? Well, they need to have an average 7% dividend yield to get my above calculations to work.
My first pick, and one I’ve recently bought, is big dividend payer Phoenix Group Holdings. This insurance, savings and retirement business offers a solid 7.7% yield and has a dividend coverage ratio around 1.7.
The current negative economic backdrop has proven challenging for some of Phoenix’s peers, but this firm expects to deliver £1.2bn of incremental, organic new business cash generation in 2022. The stock has 13 years of consecutive payments and consistent dividend growth — a big plus.
Next I’d buy Sociedad Química y Minera de Chile. It’s a surging lithium miner with a 7.9% dividend yield. Analysts suggest the dividend is well covered.
Of course, the stock is particularly dependent on lithium revenues, and that could be seen as a risk. However, the metal is a core component of the renewables revolution. I don’t see demand falling any time soon. That’s why I’ve recently bought Sociedad Química y Minera de Chile.
Finally, I’m picking Greencoat UK Wind — another recent purchase of mine. The renewable energy trust aims to increase its dividend in line with inflation year on year. Currently, the stock offers a 5% yield, which is fine as my other two picks offer yields near 8%. Next year, the dividend payment is planned to rise 13% to 8.76p per share. Dividend cover was 3.2 times for 2022, so the increase appears affordable.
The obvious concern is that wind can be temperamental. So until there is the battery technology to deal with supply and demand issues, wind could be an unreliable energy source.
