With prices rising across the board, wouldn’t it be lovely to earn a second income? I certainly think so. And there are plenty of other investors in the same boat, exploring ways to generate some extra money to help cover everyday living expenses.
The good news is that dividend-paying stocks make this process fairly easy. By simply buying and holding shares in typically larger and more mature enterprises, a portfolio can generate a recurring income stream.
So with that in mind, let’s explore how to unlock a second income of up to £400.50 with just £5,000 right now.
Exploring high-yield opportunities
By investing £5,000 in a quick-and-simple FTSE 100 index fund, investors can start earnings a passive income of roughly £146.50 overnight. That’s certainly better than nothing. But it pales in comparison to some of the higher-yielding opportunities that lie within the UK’s flagship index.
For example, Legal & General (LSE:LGEN) shares pay an impressive 8.01% in dividends today, enough to boost the income stream to £400.50.
What’s more, unlike many other high-yield stocks, the insurance and asset management group has a pretty extensive history of growing dividends over time. In fact, excluding the pandemic, the company has hiked shareholder payouts every year since 2009.
So, with that in mind, it’s no wonder that Legal & General shares have been one of the most popular income stocks to buy over the last month. At least, that’s what the data from AJ Bell has revealed.
But is this actually a good investment?
Does the dividend hold up?
Asset management demand is unlikely to disappear anytime soon. And with higher interest rates making annuities far more attractive compared to the 2010s, Legal & General actually has quite a bit of room to manoeuvre and expand its business.
The trouble lies within the firm’s financial complexity. The balance sheet is filled with long-duration assets like bonds, private credit, and real estate, as well as long-duration liabilities, most significantly pension liabilities that can span up to 50 years.
As a consequence, Legal & General’s highly sensitive to shifts in the macroeconomic landscape, particularly recessions and sudden shifts in gilt yields.
Modelling different stress test scenarios is quite challenging, given the opaque nature of its asset and liability portfolios. And as a consequence, institutional investors are being far more cautious, especially now that dividends are currently outpacing earnings.
In the short-term that’s not necessarily a problem, especially since management expects superior profits in large part from the pension risk transfer market. However, if this anticipated earnings growth fails to materialise, then, in the medium-to-long term, dividends could be on potentially shaky ground.
So where does that leave investors?
What’s the verdict?
In my opinion, today’s high yield doesn’t appear to be a dividend trap. Yet, it’s not a screaming buying opportunity worth considering to earn free money either. Instead, it’s a reflection of the complexity and opacity of this financial enterprise, sensitive to external shifts in the credit markets.
For investors comfortable with taking on this risk, there’s a compelling bull case to be made. But personally, I’m sticking with billionaire investor Warren Buffett’s advice: “Never invest in a business you cannot understand”.
