One of the attractions to me of investing in shares is the ability to earn passive income from company dividends. By investing the £20,000 of an ISA allowance, I think I could earn quite a healthy amount each year. Here is how I would try to do that through buying UK dividend shares.
Investment approach
Investing in different companies and business areas would give me the opportunity to benefit from companies exposed to different parts of the economic cycle. It would also give me diversification. That would help reduce my risk if a company underperformed.
I would split the money across 10 companies, investing in no more than two per sector. Dividends are never guaranteed. Spreading my £20,000 would mean a single company cutting its dividend would have less impact on my income.
Oil and gas
In energy, I would plump for Diversified Energy. The company owns thousands of oil and gas wells, as well as pipelines. Buying up small, old assets has allowed it to squeeze money out of the ground and fund an 11% dividend. One risk is the decommissioning costs of such old wells.
I would also buy oil major BP, with a 4.3% yield. It has global exposure and is reshaping its portfolio for changing energy demands, although any future fall in oil prices hurting profits.
Tobacco
For income, tobacco is a common choice because of its high cash flows. I would invest in Imperial Brands and British American Tobacco, yielding 8.5% and 7.7% respectively. Both have profitable businesses that benefit from established brand names. That gives them pricing power. But a decline in the number of cigarette smokers in many markets could hurt sales and profits.
Financial services
I would buy investment manager M&G. With a well-known name and established customer base, I reckon the company could keep doing well in future. It yields 8.9%.
Another company on my shopping list would be insurer Legal & General. Its iconic brand helps it attract and retain customers. I also see it as a well-run business, which has grown profits strongly over the past decade. Legal & General yields 5.9%.
Both companies risk profits falling if a stock market crash damages share returns and leads to customers shopping around, however.
Consumer goods and pharma
I would buy Dove owner Unilever too. The consumer goods giant yields 3.8% and pays out quarterly. Cost inflation threatens profit margins. That has sent the shares 12% lower over the past year, at the time of writing this article earlier today. But I like the company’s huge customer base and established portfolio of premium brands.
GlaxoSmithKline is another purchase I would make. It yields 5%. Soon it will split its pharma and consumer goods division, which could lead to a lower payout. But like Unilever, its premium brands give it pricing power.
Utilities
With a 4.7% yield, I would buy energy distributor National Grid. Its entrenched network and resilient demand should help it keep making profits. One risk is higher capital expenditure eating into profits as it responds to changing patterns of electricity consumption.
Mining
Finally I would buy Rio Tinto. It yields 9.8%. The mammoth miner faces the risk of boom and bust pricing in natural resources. That could lead to future dividend cuts or cancellation. But as only one tenth of a diversified, long-term portfolio I would be happy to hold it.