I want to build up a nest egg and getting passive income from dividends can be a great way to do it. That’s because I could get far higher rates than the interest I’d earn from bank savings. Of course, there are risks, in particular that the share price of a company may drop or dividends could be cut. Despite this, I still like to have an array of income stocks in my portfolio. Currently, the FTSE 100 is averaging a yield of around 3.5%. But through choosing the following companies, which averagely yield around 5%, I’d aim to make £1,000 of annual income from £20,000 invested.
High-yielding dividend stocks
To achieve this aim, it’s important to include a few high-yielding dividend stocks. Nonetheless, I’m still staying away from some of the highest payers on the FTSE 100, because I worry about the sustainability of their dividends. For example, despite it offering a dividend yield of over 9%, I’m not buying tobacco giant Imperial Brands. This is because I worry that growth will be negative over the next few years due to increasing regulations in the tobacco market.
It’s important to choose healthy and growing companies with dividends that can be sustained. An example of a company I own shares in is Legal & General. It has a current yield of 7%, and this is comfortably covered by profits. There’s also scope for the dividend to rise.
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I’m also particularly keen on NextEnergy Solar Fund, which is, as the name suggests, a renewable energy company. It has seen consistent dividend growth over the past few years and is currently offering a yield of 7.2%. Although it only has dividend cover of just 1.1, I’m hoping this will increase due to the high demand for renewable energy.
Finally, after its recent set of very impressive results, where annual profits climbed 69% to $74.7m, I’ve also bought gold miner Pan African Resources. This stock has seen growing shareholder returns over the years, and its dividend currently yields 5.4%.
Investing in these high-yield dividend stocks, goes a long way towards attaining my average 5% aim. But there are still risks in choosing high-yielding stocks. Indeed, if profits dip, it means that the dividend becomes unsustainable and must be cut. This is a factor I must consider.
How I plan to counter the risk of a dividend cut
Alongside these high-yield dividend stocks, I also plan to invest in some lower-yielding stocks, which have a higher level of dividend cover. This also allows these companies to invest more money in growth, something I hope will be reflected in their share prices.
The first example is drinks giant Diageo. This FTSE 100 stock has recovered strongly from the pandemic, reporting profits of £3.7bn in the year ending June 2021. The dividend only costs around £1.7bn, meaning that Diageo has dividend cover of over 2. Even though the dividend only yields 2.8%, I still feel that this is a great dividend stock.
Packaging company Mondi is another FTSE 100 stock I already happily own to help achieve my goal of £1,000 of annual passive income. Once again, its dividend is covered by more than twice by earnings, and it offers a dividend yield of around 3%. Although this is slightly lower than my 5% average, my high-yielding dividend stocks should help average it out. It’s not guaranteed of course.
