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Like many people, I own a number of dividend shares in my Stocks and Shares ISA, hoping that they can provide passive income streams over the long term.
Currently, the FTSE 100 yield is 3.3%. When I think about how to invest, I sometimes target a higher yield. In fact, in the current market, I would be happy to target a yield of 7%, or even 8%. But is an 8% yield target realistic?
One way to think about dividend yield
Dividends are paid from spare money a company has after investing what it needs to in its business. That could come from the profits the business makes. But sometimes dividends may come from other sources, such as money borrowed or proceeds from a one-off asset sale.
Over the long term, clearly, such one-off cash generation opportunities are unsustainable ways to pay dividends.
As to having lots of spare cash that does not need to be invested in the business, that can signal a company with limited future growth opportunities to be pursued. Some tobacco businesses are like that, for example.
But just because a business has lots of spare cash to pay as dividends does not necessarily mean that it does not have growth prospects. It could simply be a business that is excellent at generating spare cash – and could potentially stay that way. That can be lucrative for an ISA!
8% yields exist
For example, even within the FTSE 100, there are shares currently yielding 8% or higher, including Legal & General and Phoenix (LSE: PHNX).
Both have raised their dividend per share annually in recent years and have said they aim to keep doing so. That said, dividends are never guaranteed, so the smart investor always looks at a business and considers its commercial prospects, alongside what that may mean for its dividend.
I think Phoenix is a share investors should consider. Its focus on retirement and savings products has seen it grow a customer base of millions. Its well-known brands including Standard Life help give it credibility, while its size gives the business economies of scale.
Managing a large, complex book of pensions carries risks. For example, Phoenix has a mortgage book that contains valuation assumptions. If there was a severe financial downturn, the properties could turn out to be worth less than their current carrying value.
On balance though, I see Phoenix as a share for investors to consider.
Looking beyond the FTSE 100
While there are some shares yielding 8% or above in the blue-chip index, there are others outside it worth considering. A number of investment trusts offer high yields.
For example, I own shares in Henderson Far East Income. Its shares currently offer a dividend yield of 10.3%.
But a high yield can be a red flag that the City is nervous about the potential for a future dividend cut. As ever, whether buying high-yield or low-yield shares for my ISA, I always stay focused on how sustainable I think a dividend may be.
