Generating passive income from stocks isn’t a new concept. The ability to benefit from dividend payments from listed shares has been happening for many, many decades. Yet given the rise in the cost of living and inflation, some are trying to push the boat out in targeting very high yields. Yes, it’s possible to build a portfolio yielding 10%. But it comes with risks.
Measuring risk and reward
As with most things in life, the higher the reward for something, the higher the risk. This is the same principle when it comes to income stocks. Typically, the higher the dividend yield, the larger the risk associated with buying the stock.
To understand why, investors need to grasp that the dividend yield is made up of the dividend per share and the current share price. If the yield is something like 10%, it could be elevated because the share price has been falling. If the business is in trouble, then the yield of 10% might be sound for another year, but in the future the dividend could be cut if the company struggles with cash flow.
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It could be that the market has just overreacted, such as during a stock market crash. In this case, buying low can be extremely profitable. Or a high yield could be due to a sharp bump higher in the dividend per share payout.
Whatever the case, it’s important to understand why the yield is high and how sustainable this is before buying.
How to build the portfolio
With all that being said, it’s possible to build a diversified income portfolio yielding 10% right now. A quick glance at the FTSE 100 might pose some questions. The average yield is only 3.73%? The highest yielding stock (Vodafone) is only at 9.81%?
All of this is true, but don’t forget there are many stocks outside of the FTSE 100 to consider. For example, within the FTSE 250 there are five stocks yielding higher than 10%.
I can also look to investment trusts and exchange traded funds (ETFs). There are some great examples of trusts such as the Alternative Income REIT and Henderson Far East Income that offer a yield above 10%.
Including a mix of stocks like this helps to diversify some of my risk away. The Far East trust focuses on Southeast Asia, so it’s all about a different geography. The Income REIT looks just at property. So in taking on such stocks, investors get a blended exposure.
Good alternatives are hard to come by
I’m not going to claim that a portfolio full of 10% yielding stocks is low risk. But if I add a dozen stocks into the mix, I do believe that the risk is manageable.
As for the potential reward, I think it’s very clear. I struggle to see another income-generating asset that could provide double-digit returns in the same kind of passive way as stocks.
