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The stock market offers people an opportunity to grow a pot of cash by making smart investment choices. If treated carefully, with proper risk management and a sensible strategy, it can be a good way to earn a respectable yield above what could be achieved elsewhere, such as in cash savings.
If someone had £5k of excess funds, here’s how it could be handled.
Thinking it through
The current base interest rate is 3.75%. Someone might aim to achieve over double this return. Let’s say the target was an 8% yield. One way to achieve this would be via a strategy based on banking dividend payments. If a stock costs £100 and pays a £10 dividend each year, the dividend yield is 10%. At the same time, if an investor just owned this share, the annual yield of the portfolio is 10%.
Of course, I’m not saying just buy one dividend share yielding 8% and put all the £5k in it. But when I look at the FTSE 100 and FTSE 250, there are currently 16 companies with yields above 8%. So I think it’s possible to build a diversified portfolio with this as the target yield. Even if one of the examples has a yield of 10%, which could be perceived as high risk, it can be partially offset by a lower-risk stock with a 6% yield. Added together, the same 8% average yield can be obtained.
Granted, dividends aren’t guaranteed. So in the future, the 8% yield could be lower if some companies cut the payments. Part of this can be reduced by owning a broader selection of stocks. Yet it’s a risk, which has to be there given the potential reward of the juicy yield. If an investor’s risk tolerance is too high, it can be adjusted to target a lower overall dividend yield.
A generous yield on offer
Part of making the strategy a success is picking the right income shares. One example to consider is the Sequoia Economic Infrastructure Income fund (LSE:SEQI). As the name suggests, it’s a company that lends to infrastructure projects, making money from the interest income from the loans and bonds.
Over the past year, the share price has been flat, with a dividend yield of 8.72%. The firm’s known for a high dividend yield, supported by relatively high interest rates on its debt portfolio. Put another way, the interest rate payable on many of the loans offered is higher than traditional bank loans, due to the nature of the projects.
Yet at the same time, I wouldn’t say they are very high risk, as the company typically has some security via the physical asset being built. Therefore, it’s in a sweetspot of having predictable cash flows from the interest, but at a higher rate than usual, supporting the generous dividend.
Looking forward, I can’t see the situation changing. The dividend cover’s 1.5, meaning the current earnings per share easily cover the dividend payments. However, in terms of risk, loan defaults are a concern. The top five projects make up 21.44% of the overall portfolio, which is quite high.
Even with this, I still think it’s a good stock to consider buying in pursuit of an above-average yield.
