High dividend yields are often a sign of trouble. While they can indicate chunky payouts, distributing vast amounts of earnings to shareholders is typically unsustainable. However, by combining patience with prudent financial planning, it’s possible to build a £20k ISA portfolio with a reliable 8% yield. Here’s how.
Yield is the end goal, not the starting point
When crafting an 8% dividend portfolio, it’s easy to assume that investors need to focus exclusively on high-yield income stocks. But this approach, in many instances, is an error. Why? Because, as previously highlighted, chunky yields often get cut.
Such unsustainable income stocks are called yield traps. And it’s the last thing any investor wants in their portfolio. Don’t forget that when payouts are cut or even outright cancelled, the stock price also has a habit of taking a nose dive in a one-two punch to investor wealth.
Instead, the focus needs to be placed on income stocks with a robust cash-generative enterprise behind them. Even if the yield is relatively low, a company that generates recurring revenue at high margins will often find itself able to raise dividends over time. And in the long run, a modest initial yield can evolve into a sizable one.
For example, let’s take a look at what’s happened with Relx over the last decade. Since 2013, the research and analytics provider has been hiking up dividends by a couple pence fairly consistently. And while investing in 2013 would have only secured a 3.6% yield, the bumps in income now place the yield on an original cost basis just shy of 8%.
Diversification and risk
Constructing an income portfolio using stocks with the potential to grow dividends can reap much higher returns in the long run while keeping risk in check. However, that doesn’t make it a foolproof strategy, and as with any investment, risk can’t be eliminated entirely.
After all, even the largest industry titans can eventually be disrupted. And even Dividend Aristocrats can see their multi-decade winning streaks come to an end.
Careful research and analysis can help eliminate weaker businesses from consideration. But even then, all it takes is a previously unknown or unforeseen external threat to disrupt cash flow. That’s why it’s generally prudent to build a diversified ISA.
By ensuring a portfolio contains a collection of top-notch enterprises, the impact of one becoming disrupted can be offset by the others. And to make certain no single threat can affect more than one business, diversification works best when investing in a broad range of companies operating in different industries and geographies around the world.
The bottom line
Building a reliable, high-yield portfolio takes time. But thanks to the ongoing correction, dividend yields among FTSE 100 and FTSE 250 stocks are currently elevated. Therefore, 2023 may present the perfect opportunity to kick off an income portfolio with a head start.
