There’s a clear balance to be had when weighing up the risks versus the rewards of a potential investment. With dividend shares, this is precisely the same.
A high-yield option likely carries more risk around the sustainability of the passive income, but at the same time, the cash payments could be very juicy. If an investor did decide on a higher-risk approach with a sum of £8,000, here’s what could be achieved.
How to think about it
The FTSE 100 average dividend yield at the moment is 3.46%. Technically, anything above this average could be considered a high-yielding option. Yet in reality, I’d only classify a stock as being high-yield if it’s above 7%. Currently, there are six shares in the FTSE 100 that fit this profile. If I extend it to the FTSE 250, there are another 25 companies.
So even though, at a company-specific level, these stocks might be riskier to buy, an investor could still look to diversify some of this by holding a portfolio of dividend shares. There’s plenty here to allow an investor to buy a dozen stocks and still achieve an average yield that’s generous. That way, if one of the companies cuts the dividend, the overall impact’s more limited.
Even with this, investors do need to be aware that firms with a very high yield could cause problems over time. Sometimes, the yield’s been pushed higher because the share price has been falling rapidly. This could mean there’s trouble brewing, which could cause management to cut the dividend.
Renewable energy as a theme
One example an investor could consider if they were building this portfolio is Greencoat UK Wind (LSE:UKW). Greencoat’s a renewable energy investment company that generates revenue through owning and operating wind farms across the UK. Over the past year, the stock’s down by 14%, with a current dividend yield of 8.83%.
Greencoat’s an investment trust, with one of the key aims being to provide steady returns in the form of dividends. It has long-term power purchase agreements (PPAs), which means that cash flow for years to come can be forecasted fairly easily. In turn, this helps to provide stability when it comes to paying out income.
One reason why the yield’s increased in the past year is the dip in the share price. This is partly due to lower power prices, alongside the risk from the UK government, with it hinting at potential changes to renewable energy subsidies. Naturally, this would impact future revenue.
Even with these risks, renewable energy’s a key long-term theme, with the generous yield being an added perk.
Looking at the numbers
If an investor put £1,000 in eight dividend stocks that had an average yield of 8.5%, they could stand to make £680 in the following year. If this money was put back into the stock market, further income payments could compound faster. For example, in year six it could pay £1,080.
Granted, this isn’t guaranteed, but it shows what can be achieved with a slightly higher risk tolerance.
This post was originally published on Motley Fool
