Following the recent interest rate hikes by the Bank of England, dividend yields across the London Stock Exchange have gone through the roof. While not every enterprise is offering chunky payouts, the FTSE 350 is filled with stocks offering a 7% yield, or higher. In fact, as of today, there are 55 of them.
But with the British economy slowly returning to stability, a stock market recovery is on its way. It might have even already started. As such, today’s vast collection of impressive yields might not be around for much longer. With that in mind, let’s explore the best way to lock in a 7% payout with £10k.
Avoiding the yield traps
One of the biggest mistakes a novice investor can make is rushing into a bad decision. Time might be ticking to capitalise on bargains today, but there will always be more in future. So it’s fine and far wiser to take as much time as needed to make an informed investment decision.
This is especially important when venturing into high-yield stocks. Why? Because most have a habit of being utterly unsustainable. Don’t forget the yield isn’t pushed up by just dividend hikes. If a stock price falls off a cliff, the percentage payout rises as well.
Since dividends are ultimately funded by excess earnings, it’s paramount to investigate why a yield is so high. Often, it’s because of a sudden share price nose dive. And in this situation, it’s important to investigate why.
A temporary disruption that could be solved in a few quarters is far less concerning than a company that’s revealed to be financially compromised. And investors who snap up shares in the latter on the back of a chunky payout will likely come to regret it. Apart from the fact dividends are more likely to be cut, the announcement alone could send a stock spiralling downwards even further.
The ongoing economic storm may only be temporary. But its adverse effects on smaller businesses might be permanent, especially for firms that have grown reliant on debt financing over the last decade.
Therefore, of the 50+ companies offering a high payout today, the vast majority of them are likely to be traps. That’s why it’s sensible not to limit selections just to companies with the same yield as my target.
It’s still possible to hit a 7% payout by blending a combination of lower- and higher-paying stocks. And expanding the range of candidates to any firm with a yield of at least 5%, the amount of options in just the FTSE 350 increases to around 115 companies.
Apart from the risk reduction benefits of diversification, a portfolio is likely to be far less volatile at the same time. And even if the total portfolio yield falls short of my target, a selection of top-notch stocks may eventually change that over time as businesses hike their dividends, rewarding patient shareholders.