Many investors use their Stocks and Shares ISA as a way to boost their passive income streams. I know I do. To target an inflation-busting 6% dividend yield in my ISA right now, here is how I would invest £20,000.
Draw up a longlist of options
I would start by drawing up a list of shares currently yielding 6% or more. I would base that on their current yield, but I might also consider some shares that yield nearly 6% and seem likely to grow their dividend soon. For example, Anglo American yields 5.5% and its most recent dividend raise was a hefty 64%.
When making such a list, I would pay attention to special dividends. Sometimes these are excluded from a company’s reported yield. But while they are rare for some companies, other firms like Direct Line make use of special dividends fairly often.
Narrow the list
Before even getting into the details of the companies concerned, I would then start to narrow my longlist.
Different investors take their own approach to this. I would consider questions like the following.
Is there strong reason to doubt that the coming year’s dividend will match last year’s? For example, on paper, Ferrexpo yields 18% but I doubt the embattled mining group with its operations in Ukraine will maintain its dividend.
Does a company operate in a notoriously cyclical industry? For example, miner Rio Tinto yields 9.4% but I see a risk that it might slash the dividend the next time metal prices fall. Builder Persimmon yields 11% — but would that dividend survive a housing bust?
Is the dividend consistently more than free cash flow? For example, several years ago the gap between free cash flow and dividends at Imperial Brands was widely seen as a sign that the dividend would have to be cut – as it was.
I would eliminate these companies from my list. That does not mean I would not consider them at other times for my portfolio. But when my investment objective is very clearly a 6% dividend yield, I do not want to invest in any companies where I see warning signals that they might not sustain such a yield.
Choose attractive businesses I understand
At this point, there should still be quite a few names on my list, from British American Tobacco to Legal & General.
So far I have focused for speed on the financial characteristics of the shares, not the quality of the underlying businesses. Now I would limit my list to companies I understood. I would exclude any that I did not think had solid business models with some sort of competitive advantage that could help them sustain future profits.
Targeting a 6% dividend yield
Once I had my shortlist, I would split my £20,000 across five to 10 of them. That would give me diversification, to help reduce the impact on my passive income if one of the shares cuts its dividend in future.
A lot of names might operate in the same area. For example, I expect financial services firms Direct Line, Legal & General, M&G, Jupiter Fund Management and CMC Markets could all end up on my shortlist. But I would not want to concentrate too much of my £20,000 in one sector.