With inflation soaring, now could be a good time to build a dividend-heavy portfolio and get my money working. Thankfully, with UK shares missing out on international rally after international rally, there’s plenty of cheap stocks with high yields to pick up.
But it’s not just a short-term inflation hedge. By buying stocks at discounts while yields are high, I can look to build a passive income-generating portfolio that could serve me well in the years ahead.
Why dividends?
If we invest for dividends, we can either use the proceeds to fund our lives — like a second income — or reinvest to take advantage of compound returns. That very much depends on our individual preferences.
Dividend payments are also typically more stable than the fluctuating prices of stocks. Investing in established dividend stocks tends to be a less volatile ride.
Even during market downturns, companies that pay dividends may continue to do so, providing a level of stability and income certainty.
As such, dividend stocks are often used as part of a more defensive strategy. Stocks that consistently pay dividends tend to be well-established and also have a track record of generating stable earnings. Stocks like Legal & General are an excellent example.
Here’s how Legal & General’s 8.45% yield could compound — without share price growth — with an initial £1,000 investment.
| Timescale | 8.45% yield |
| 5 years | £1,523.51 |
| 10 years | £2,321.09 |
| 20 years | £5,387.48 |
| 30 years | £12,504.85 |
Moreover, right now, high yields are something of a hedge against inflation. But moving forward, I’m envisaging a time when inflation is low, but I’ve locked in yields between 6-9%. That’s because the yield I receive is always dependent on the price I paid for the stock.
Of course, there’s always risks. Payments can be cut or cancelled at any point. But investing for dividends is largely considered less risky than investing purely for growth.
The plan
Buying dividend stocks when prices are low can be advantageous for several reasons. This is because share prices and dividend yields are inversely correlated.
Currently, there are more than 10 stocks on the FTSE 100 with dividend yields in excess of 7%. This reflects the dire state of the index, with dozens of companies, and even sectors, failing to deliver the type of share price growth we’ve seen in the US.
In fact, over five years, the FTSE 100 is down 1.45%, while the S&P 500 is up 61%. While this is naturally a shame, I also see great value in UK stocks.
Diverse picks
Unsurprisingly, several dividend big hitters are from the same sector. While there’s nothing wrong with owning Aviva, Legal & General and Phoenix Group at the same time, it’s good practice to spread risk across the market.
I also see opportunity in stocks like Lloyds, with its 5.5% yield and 3.25 times coverage, and housebuilders. The latter are trading at lows not seen for a long time, and that’s why we’re seeing such high yields.
It’s certainly worth highlighting that mortgage-heavy Lloyds and housebuilders may continue to experience pressure this year, but they already look cheap. A downturn may already be priced in.
