A year ago, inflation in the UK was running at 1%. Since then, increased economic activity post-lockdown has seen inflation levels rise quickly. The latest reading was 2.5%, with the Bank of England forecasting that it could reach 4% at the end of the year. With this in mind, if I have £1,000 sitting in cash that I don’t need, I’m thinking about investing it in top dividend stocks.
Understanding the impact of inflation
Inflation erodes the value of my money. Let’s consider an example. If I kept my £1,000 in my current account, my interest rate is 0%. With inflation at 2.5%, it means that my purchasing power will decrease by 2.5% a year. Given that the Bank of England base rate is only 0.1%, I’m going to struggle to find any high-interest savings account or Cash ISA that will give me a 2.5% annual return.
The bottom line in this regard is that to avoid inflation eroding the value of my money, I need to find a return of at least 2.5% just to break even. With forecasts that it could run even higher, ideally I want to invest somewhere with a return of at least 4% to be on the safe side.
I could think that this is easier said than done, but top dividend stocks do offer me a solution for my £1,000. Clearly, nothing comes without a level of risk, but given the outlook for inflation, I’m happy to take on some risk in order to try and negate the impact of inflation.
Buying top dividend stocks
When I’m talking about a top dividend stock, I’m referring to a company that pays out income in the form of a dividend. As a shareholder, I can easily look at the amount of shares I own and the dividend paid per share. I can also relate this to the current share price and work out my dividend yield.
Within the FTSE 100, the dividend yields vary. Some companies aren’t currently paying out any dividends. Others are, with some generous yields available.
I don’t really want to get too greedy and target ultra-high yields as this could be risky. This could be because the yield is being boosted due to a falling share price. This could be bad news further down the line, as a company in trouble will likely cut the dividend as a way of helping its finances.
Even with this in mind, there are sustainable top dividend stocks within the index. In the 4-6% dividend yield range, there are currently a dozen different FTSE 100 stocks that I can put my £1,000 into.
I’d look to pick half a dozen of these and split up my £1,000 evenly into the mix. I feel this gives me a well-balanced overall portfolio of top dividend stocks. So even if inflation continues to move higher later this year, the income received via the dividends should allow me to offset this impact.
