How I’d invest a £100K SIPP to target £8K in dividends annually

Christopher Ruane sets out some principles he adopts when investing his SIPP and explains how he would aim for a target dividend income.

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A SIPP can be a useful way to generate income, whether to draw down now (in some cases) or reinvest to build the long-term value of the SIPP.

I think the current stock market offers some excellent opportunities for me to generate income in my SIPP while investing in blue-chip FTSE 100 dividend shares.

Here is how I could use a £100K SIPP to target £8K annually in dividends.

A word about compounding

Before I go on, let me explain why I mentioned building the long-value of a SIPP by reinvesting dividends earned from the shares I own in it.

That is known as compounding. Legendary investor Warren Buffett compares compounding to pushing a snowball downhill. As it goes, it picks up more snow and in time that picks up snow.

In the case of a SIPP that ‘snow’ is money from dividends – and my timeframe can be long enough for the impact to be sizeable.

If I compound a £100K SIPP at 8% annually for the next 25 years (without adding a penny of new capital), at the end of the period it will be worth around £684,00 and earn me some £54,780 in dividends annually. That could be very handy retirement income!

Targeting an 8% yield

To earn £8K annually from a £100K SIPP, I need to earn an average dividend yield of 8% (after the impact of fees; in reality, I would choose my SIPP carefully as over a long time period such fees can eat into my returns a lot).

But I would not start just by looking for high-yield shares. After all, dividends can be cancelled at any moment.

I would look for what I think are good businesses with some competitive edge that can help them to do well in a sizeable, resilient market. Only then would I consider yield.

As 8% is an average, I could invest in shares with a lower yield as long as I still achieved my target overall. I would diversify my SIPP across a range of shares to reduce the impact if one of the shares performed poorly or axed its dividend.

Choosing shares for a SIPP

As a long-term investor, the sort of timeframe commonly associated with a SIPP makes sense to me. It helps focus my mind on finding shares to buy that I believe have excellent long-term commercial prospects.

An example is financial services provider M&G (LSE: MNG).

The asset manager has a customer base in the millions, operates in several dozen markets, has a well-recognised brand and can benefit from strong demand for asset management.

As the market is crowded, one risk I see is competitors pushing down profit margins. But over the long term I think M&G can do very well. It is a handsome dividend payer. At the moment, M&G shares yield 8.8%.

In recent years, the firm has raised its annual payout. It may do so again in future.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

C Ruane has no position in any of the shares mentioned. The Motley Fool UK has recommended M&g Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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