Buying FTSE 100 dividend stocks in an ISA might be a good way to start building wealth in 2021. Interest rates are at rock bottom, so cash held in a bank account or Cash ISA offers relatively poor returns. Bond prices are high — good for those looking to sell — but yields are low, which is bad for new investors.
FTSE 100 dividend-paying stocks can offer higher yields than cash or bonds. Plus there is also the prospect of the share price increasing and boosting returns. Taking the dividend payments and reinvesting them in more shares can supercharge returns through the power of compounding. Dividend reinvestment is especially powerful when done with UK-listed stocks inside a Stocks and Shares ISA as there is no tax to pay on the dividends.
Dividend reinvestment
I don’t think FTSE 100 dividend-paying stocks get the attention they deserve when discussing wealth building. The buzz is often around those high-flying growth stocks. However, dividend reinvestment is an acknowledge cornerstone of a wealth-building investment portfolio. An analysis of ISA millionaires’ portfolios revealed that FTSE 100 stocks regularly featured in their portfolio, and FTSE companies almost always pay a dividend. In fact, over half of those millionaires owned FTSE 100-listed Lloyds Banking Group.
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Covid-19 crushed Lloyd’s share price and forced a dividend cut. Before that, Lloyds had, since 2014, offered impressive dividend growth and chunky yields. Lloyds was regarded as a highly profitable bank with good capital buffers and a secure looking dividend before the twin threats of a hard Brexit and coronavirus. The former has been avoided, and vaccines against the latter are being rolled out. So there might be an opportunity to buy Lloyd’s as a potentially great dividend payer. However, I am looking elsewhere right now.
My top 3 FTSE 100 dividend stocks
Instead of Lloyds, I am looking at three FTSE 100 dividend-paying stocks for 2021: Aviva, an insurer, GlaxoSmithKline, a pharmaceutical behemoth, and Relx, an information and analytics provider. Together I think they provide a decent yet relatively safe yield and the prospect of share price growth.
GlaxoSmithKline and Relx are FTSE 100 dividend hero stocks. That means that they have not cut their dividends at all in the last 10 years. These are expected to yield around 5.8% and 2.5% respectively once all dividend payments for 2020 are completed (which will spill into the 2021 calendar year). Dividends are forecasted to be covered 1.45 times by earnings for GlaxoSmithKline and 1.72 times for Relx. Coverage of 1.5 or greater, ideally more than 2, is where I want to be. GlaxoSmithKline’s earnings cover is pushing it, but given the company’s track record, I am willing to give it the benefit of the doubt here.
Aviva has a forecasted yield of 7.8% and an earnings cover of over 2, so things look good from now on. However, Aviva is a cyclical stock and has cut its dividend three times in the last decade. Combining it with the more defensive investment in GlaxoSmithKline, and a fellow dividend hero stock like Relx makes sense. It plumps up the yield in good times, but if Aviva does cut again, I would expect the other two stocks to offer downside protection to the dividend yield.
