Having 20 grand in the bank is a nice lump sum of capital to get started generating a chunky second income using the stock market. When leveraging a FTSE 100 index fund, it’s enough to instantly start earning £660 passive income overnight. And for investors willing to take on more risk, there are some dividend-paying stocks offering more than 8% right now.
Take Legal & General Group (LSE:LGEN) as an example to consider. The insurance stock currently has an 8.4% payout, enough to start earning a £1,680 second income straight away. So what’s the catch?
Investigating the yield
Generally speaking, a high dividend yield usually stems from a sudden drop in a stock price. Yet looking at Legal & General, that doesn’t appear to be the case. In fact, the shares are actually up close to 15% in the last 12 months, and the company’s been hiking shareholder payouts for the previous four years in a row.
That certainly makes the high yield seem like it’s here to stay. But if that’s the case, why aren’t more investors jumping aboard to take advantage? Despite recent outperformance, there’s growing concern among institutional investors that earnings will soon be under pressure.
Higher interest rates have made their long-term annuity financial products very popular in recent years, resulting in gold-rush-like growth. However, with rates coming down, demand’s starting to slow. And in the meantime, all the recently-created annuity products issued during the higher interest rate environment now introduce long-duration risk exposure as well as miss-pricing risk.
This creates two problems: lower future growth and increased sensitivity to market shocks. And if Legal & General fails to hedge against these threats, earnings and, in turn, dividends could end up on the chopping block.
A risk worth taking?
The risk of earnings pressure is why Legal & General shares offer such a generous dividend today. However, despite these looming challenges, it’s worth pointing out that the company’s in a fair strong position at the moment.
The group maintains a Solvency II ratio of 217%. That’s a very strong signal for robust financial health and provides a significant capital buffer against a market downturn.
At the same time, management’s been busy executing numerous operational efficiency schemes to bolster margins across its key divisions.
For example, its Asset Management division’s on track to steadily grow its operating profits to as high as £600m by 2028, versus the £401m achieved in 2024. And with the long-term demand for its Institutional Retirement products climbing on the back of an ageing population, dividends might be more sustainable than many investors currently think.
The bottom line
All things considered, Legal & General seems to offer a compelling case for investors seeking to build a second income stream. Admittedly, this comes paired with an elevated risk profile compared to other dividend opportunities in the FTSE 100.
But given the level of payout, investors with a higher risk tolerance may want to investigate further.
