Income stocks form a large part of my portfolio. And this reflects my strategy to build wealth using passive income and reinvesting my profits. This is a process called compounding returns or compounding interest.
Over time, this strategy could help my portfolio grow without having too much exposure to riskier growth stocks. Instead, if I was investing £10,000, I’d focus on companies with solid valuations that should continue to perform well.
What are compound returns?
I’m fortunate not to need my stock market profits right now. Instead I reinvest the money I make and the passive income I receive. This is what allows me to benefit from compound returns.
This is the process of earning interest on my interest. And the longer I do it, the more I earn.
For example, let’s take housebuilder Crest Nicholson. Right now, it’s offering a dividend yield of 5%. That’s pretty good and slightly ahead of the FTSE average.
So, if I were to invest £10,000 in Crest Nicholson today, I’d expect £500 in dividends over the year.
However, if Crest keeps its dividend at 5% and I keep reinvesting my chunk of its payout, I could expect my £10,000 to be worth £27,000 in 20 years. That’s the power of compounding.
In fact, if I were to reinvest my dividend for 30 years, I could expect more than £47,000. That would certainly help me in my retirement.
The key to compound interest is starting early. The more years I reinvest, the more I’ll have in the end, if all goes to plan (and of course, that’s not guaranteed).
My top income stocks
However, if £10,000 was all I had, I wouldn’t invest it all in one place.
Right now, there’s a wealth of companies offering big dividends. But mega dividends aren’t always sustainable. If I’m going to reinvest my income into stocks for the long run, I want to pick companies that I think are still going to be in business in 20 or 30 years.
Banks and insurers are good places to start. Some of these stocks are offering strong dividend yields right now.
A personal favourite of mine in Lloyds. The lender offers a 4.3% dividend yield and I feel it’s going to still be in business many years from now. It’s also quite cheap today. Lloyds is less diversified than its peers and that might be one reason for it appearing cheaper. But I like its focus on property.
Legal & General also looks like a sensible pick. It’s offering a whopping 7% yield right now on the back of a stellar year. That figure might not be sustainable, but it’s a cash-generating business that has a strong track record of paying dividends. The insurance industry isn’t going away any time soon either.
Housebuilders look like good picks to me too. There’s a shortage of homes in the UK and that’s been the case for decades, so I think the long-term credentials are positive. One of the largest housebuilders, Barratt Developments, is offering a 5.75% dividend yield. I think it’s a stable bet for the long run and the yield is certainly attractive.
Using this strategy, I’m hoping to grow my portfolio, and if I’m lucky, retire early.