Some investors take a very clear approach when it comes to investing their Self-Invested Personal Pension (SIPP). They focus on high-yield dividend shares and try to build substantial income streams, compounding the dividends along the way.
This approach can have both pros and cons. Here is a trio of things to think about when deciding whether it might make sense for your own SIPP.
Growth and income can both help you build wealth
Seeing dividends pile up can feel good, partly because they are not subject to tax while inside the SIPP wrapper.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
By contrast, putting money into a growth share and holding it potentially for decades without receiving a single dividend may seem less exciting. But growth shares can help build wealth, if they end up being sold at a higher price.
Dividend shares and growth shares typically offer different routes to trying to increase a SIPP’s value. In fact, it is possible for both to do so.
High yield can a red flag, but isn’t always
As a general rule, I think it makes sense to invest by finding good companies and then assessing whether their share price is attractive. In practice, a juicy dividend can sometimes distract investors who aim to do that.
They start by finding a high-yield share. They look at whether the payout is covered by earnings. Then, they try to convince themselves that the risks (such as the dividend being cancelled) are manageable.
Sometimes, though, a high yield can be a red flag that the City has doubts about whether a firm will be able to maintain its dividend.
Such dividends are sometimes cut or even cancelled. Others stay the same or grow – and investors can earn chunky passive income streams.
So I think it is important as an investor to be honest about the risks of a given share, not just the potential rewards.
Staying diversified always matters
Often, high-yield shares cluster together in certain stock market sectors.
Right now, for example, three of the FTSE 100’s five highest-yielding shares are financial services firms. The other two are property companies.
The FTSE 250 shows a different bias but the same pattern. All five of its highest-yielding shares are linked to renewable energy.
It is always important to manage investment risk by diversifying. With high-yield shares clustering in certain sectors, that can take a concerted effort.
By nature, a SIPP is a long-term investment vehicle. Its lifetime will likely involve periods when cyclical shares are at different points in the economic cycle. That could mean depressed share prices, dividend cuts, or both.
I did not own any renewable energy shares in my portfolio recently, so I took the chance to add Greencoat UK Wind (LSE: UKW).
The company owns stakes in a number of wind energy projects. That has helped it grow its dividends annually in recent years. The current dividend yield is 10.7%.
The share also sells for a substantial discount to its net asset value, suggesting it could be a bargain.
Still, as the past year’s share price performance and high yield suggest, some investors are nervous about the prospects for energy funds, including this one. Changing attitudes on energy policy combined with current energy price volatility could hurt profitability.
I reckon those fears are more than factored into the current share price, though, so I happily bought the share for its passive income potential.
