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Forget cash ISA rates, here’s how I’d get 6% from FTSE 100 dividends

I have a friend who invested in a cash ISA some years ago, and he got a pretty good introductory offer of 6% per year interest. That was only for a fixed period, dropping to a variable rate after that. But he reckoned it was a good enough start and he’d maybe look to transfer in the future.

Do you know what variable rate he was on a couple of years after his introductory period ended? Just 0.1% per year. Yes, a tenth of one percent! Disillusioned, he promptly transferred his cash out and back into an ordinary savings account (which was paying a couple of percent at the time), losing any future tax relief on that early cash.

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Stocks & shares

Unfortunately, he hadn’t realised how easy it was to invest in a stocks & share ISA, and he’s now considering doing exactly that. He thoroughly dismisses the cash ISA as the rip-off it really is, especially as he can see plenty of individual FTSE 100 shares which are providing dividend yields in excess of his original 6% on their own.

How would I go about searching for a relatively reliable 6% dividend return from a stocks & shares ISA?

I’ve showed a couple of ways of putting together an initial portfolio of dividend shares. Going for the biggest dividends came up with an overall forecast yield of 8.2%, while going for biggest market-caps resulted in a 5.8% yield.

One indicator of a dividend’s reliability is its cover by earnings — if it’s not earning significantly more cash than it’s paying, future dividends can face increasing risk. But required cover really depends on the business. Utilities suppliers, for example, famously have very clear forward vision and can keep dividend payments going with less cover than others.

If I do a search on the FTSE 100 for companies offering forecast dividend yields of better than 5%, with minimum cover by earnings of 1.5 times, I get an interesting mix.

Best dividends?

The top three are all house-builders, with Taylor Wimpey coming top with forecast yields of 11.7% this year, and 13.6% next. That includes special payments too, but the firm has a policy of also  boosting its ordinary dividends over the long term.

BHP Billiton is in fourth place with a yield of 6.6% this year, covered 1.6 times by earnings. Miners are cyclical and the sector is just coming out of a commodities slump, but long-term demand is largely guaranteed.

Royal Dutch Shell figures in the list, with forecast dividend yields of 6.1% this year, and 6.2% next. And while the oil giant kept on paying the annual cash throughout the oil crisis, we’re now looking at returning cover of 1.4 times for 2018, followed by 1.7 times in 2019.

British American Tobacco offers a yield of 7.5% (covered 1.45 times) this year, rising to 7.9% (covered 1.5) times next year. And Legal & General, comes in with forecast yields of 7.2% and 7.9% (each covered 1.8 times).

I’d be tempted to add National Grid with a 5.6% yield, which is covered less at 1.2 times. But it looks like a very solid utility firm.

I reckon that makes a good start for a diversified income portfolio with an overall yield of 7.45%. That should beat the pants of any cash ISA.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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