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Forget the top Cash ISA rate. I’d pocket 7.7% here

The number of people taking out a Cash ISA each year has slumped since 2008-09 when 12,234 were attracted to the idea. In 2017-18, that had dropped to 7,783, and the reason is clear — today’s very low interest rates. The top easy-access rates you can get these days top out at around 1.35%, which isn’t even enough to cover inflation. My only puzzlement is over why those 7,783 folk thought getting one was a good idea.

But the cash has not gone into Stocks & Shares ISAs, as the number of those has remained pretty much constant. And that’s a shame, because I see a Stocks & Shares ISA as a very good thing.

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Strategy

It’s a bit more work than cash, as you have to decide which shares to buy. But I think there’s a relatively straightforward way to make a small selection. I’d start with a list of the FTSE 100‘s biggest dividend payers, and work my way down from the top. Then for each one, ask three questions.

Is the company in the same sector as one I’ve already selected? If it is, skip it, because it will only be a small portfolio and I want some diversification. I’m only going to pick five shares, and I don’t want the risk of two that could go bad together.

How about the reliability of the dividend? Is it well covered by earnings? The necessary cover varies from business to business, with more predictable and cash-generative ones (like energy suppliers) not needing the same cover. If it’s low, is there a special component and does it look like there will still be decent long-term levels?

Finally, I’d check on recent Fool articles on each stock to see if there are any red flags.

Selection

First is Evraz, a Russian steel maker with a forecast dividend yield of 12.8%, which is huge. But at just 1.2 times, cover is weak for a potentially volatile business. Finally, the share price has been plummeting and the chairman has been selling. That’s out.

Imperial Brands is next, yielding 11.1%, with 1.3 times cover. I’d prefer higher cover, but it’s a cash-rich business and I think that’s acceptable. The big yield is down to the falling share price, but I think the fear is overdone. So that’s in.

Then comes housebuilder Taylor Wimpey on a yield of 9.3%. Again cover looks low at 1.1 times, but that includes a special dividend and I think there’s enough cash generation to keep decent dividends going. Persimmon is next on 8.9%, but that would be a sector duplicate.

BT Group is offering 7.8%, covered 1.5 times, but analysts are expecting a cut next year. I’ll pass.

Insurer Aviva is next, with a 7.3% yield covered 1.9 times, and no red flags. It’s in.

Skipping shares that don’t fit my criteria, I reach the recovering Centrica (5.5%), and Royal Bank of Scotland (5.1%) to make up my five stocks.

That gives me an overall expected yield of 7.7%, which wipes the floor with a Cash ISA while having the potential for long-term share price gains as a bonus.

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Alan Oscroft owns shares of Aviva and Persimmon. The Motley Fool UK has recommended Imperial Brands. 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.