Dividends stocks are well represented within my portfolio. These stocks provide me with income on a regular basis, often quarterly or biannually.
However, dividends are by no means guaranteed. Companies can cut or halt their dividends without warning — so it can pay to look carefully at the sustainability of the yield.
I can either use these dividend payments to fund my life in the near term, or reinvest them.
So let’s take a closer look at my options.
Investing for now, or for later?
If I were to invest £10,000 in stocks paying a high, but achievable, 7% yield, this year I could expect to receive £700 in dividends. That’s a decent return and it could be enough to help fund my life. Maybe it could pay for a dinner out each month, or help me with my bills.
However, if I don’t need the money now, I can reinvest it. This allows me to benefit from something called compound returns. This is essentially the process of earning interest on my interest.
So if I invested my £10,000 in stocks paying 7% a year, and reinvested my dividends year after year, after a decade I’d have £20,000. If I was to stop reinvesting my dividends at this point, I could generate £1,400 a year in passive income.
However, the real gains come when I leave my money for longer, and when I contribute regularly. So if I were to follow the same strategy for 35 years, investing £320 a month, and increasing my monthly contributions by 5% a year, at the end of the period I’d have £1.2m.
That’s a huge potential return and highlights the importance of investing regularly and for the long run rather than looking for quick wins.
Picking wisely
Of course, this strategy only works if I pick my stocks well. With £10,000, I’d probably split the money three ways. That’s because I like to do my research, and I may struggle to keep up with all the developments if I were to pick 10 stocks, for example.
My first pick would be NextEnergy Solar. As the name suggests, this is a solar-focused trust, which currently offers a 6.5% dividend yield. The portfolio comprises 99 solar assets — the majority in the UK.
Forecasts are for payouts of 7.52p and 8.36p in 2023 and 2024, up from 7.17p this year. That’s clearly positive. However, the forward coverage is between 1.3-1.5. That’s ok, but I’d feel more comfortable closer to two. Despite this, I’m buying this stock this month.
Phoenix Group Holdings is an insurance, savings and retirement business offers a 7.7% yield and has a dividend coverage ratio around 1.7. That’s a little more steady. It’s not a business that will likely offer me much in the way of share price growth, but for the purpose of a compound returns strategy, I think it’s a great buy. I’ve recently bought this stock.
My final pick is Close Brothers Group. It’s a FTSE 250 firm providing securities trading, lending, deposit-taking and wealth-management services.
The next year might be challenging for the lender with slow growth forecast for the loan book and sizeable charges for the Novitas legal finance business. However, I’m attracted by the long-term prospects, low valuation (P/E of nine) and the 6.5% yield.
