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Putting money into a few high-yield blue-chip dividend shares can sometimes be a lucrative approach to generating extra income without working to earn it.
But the approach can have pitfalls too. Dividends can be cut, for example – and capital values may also fall. After all, a high yield can sometimes indicate concerns about whether a company will cut its dividend in future. That can weigh on the share price – though some investors do very well by buying bargain shares that in fact maintain their payouts.
High hitters in the top-tier index
At the moment, the three highest yielding dividend shares in the FTSE 100 index are Legal & General (LSE: LGEN), Phoenix Group and Mondi.
They yield 8.0%, 7.3% and 6.8%, respectively.
So someone who invested £5k evenly across the trio ought to be earning a yield of 7.4%. That should translate into around £369 of dividends per year.
Growth potential
If the firms maintain their payouts, over five years that would add up to some £1,845 of passive income.
But what if they grow them?
Mondi has been holding its dividend flat. Weak pricing in some parts of the paper market has hit profits. So I expect the dividend may not grow in the next several years.
Still, the long-term demand outlook for paper and packaging should be significant. Mondi has deep manufacturing capabilities across many markets, as well as lots of existing customer relationships.
By contrast, both Phoenix and Legal & General aim to grow their dividend per share annually – and have done that in recent years. Even if they both manage just 2% per year growth (in line with Legal & General’s target), that could add another £50 or so of dividends over the coming five years. That would mean the £5k invested today ought to earn just under £1,900 in dividends across that period.
Managing the risks
Mondi’s challenging paper market is not the only risk here, though.
Phoenix and Legal & General are both in financial services. They both focus on the retirement end of the market.
Concentrating two-thirds of the investment in the same economic area is an unnecessary risk, I reckon, but an investor who already owns other shares might be able to do that while still staying diversified.
A risk I see is a financial market downturn hitting portfolio valuations. That could lead policyholders to pull funds from Phoenix and Legal & General, hurting profits.
Legal & General faces other risks. It plans to sell a large US business. That will generate sizeable cash that can help fund dividends and share buybacks.
However, it is also likely to remove a chunk of current revenues. That could hurt overall profitability down the line.
Serious income generation potential
But Legal & General has strengths too. Like Phoenix, it has a proven business model and a large long-term client base.
Again like Phoenix – the owner of Standard Life – Legal & General has a long-established, well-known consumer brand that can help it win and retain business.
Over time, I see both — and Mondi — as dividend shares investors should consider.
