I go for UK shares offering high dividend yields to build up a second income stream.
The strategy seems straightforward enough.
Just pick the FTSE 100 stocks paying the biggest yields, stash them away in a Stocks and Shares ISA, and forget them, right?
Is biggest best?
That’s a low-effort approach. And I think it should do well over the long term. I reckon it could beat a Cash ISA hands down, for example.
But I expand on this simple strategy in two key ways.
Not all high-yield dividends are equal. And sometimes, a big yield can be a loser. My top example right now is Vodafone, with a huge forecast 10% dividend yield.
Buy some Vodafone shares and keep them for a decade, and we’ll be laughing, yes? Well, maybe not.
Someone who did that 10 years ago could have pocketed some nice cash. But they’d have seen the share price crash by 67%.
We need to see cash
It’s no good bagging the income if we lose two-thirds of our capital at the same time, is it?
So that’s my key, number one, priority.
It’s to insist on strong cash generation that’s easily enough to cover the dividends, and to be confident that it’s sustainable.
That’s exactly what Vodafone didn’t have. If a company pays out dividends that it can’t cover comfortably from cash generated by earnings, it has to come out of its capital value.
There ain’t no such thing as a free dividend.
Sell shares? What?
That one rule on its own would, I think, greatly increase my chance of earning a better second income. I really could then just sit back and forget.
But I make one more change, which might shock a few long-term investors. I evaluate my holdings regularly, and I’ll sell some stocks and buy others if I think I see something better.
I expect today’s big dividend yields to fall over time. And that’s just because I think the stock prices are too low, and they’ll rise in the future.
Outing value
Look at Aviva‘s 7.8% forecast yield. I think it’s high because Aviva’s shares are too cheap. So what if they double in price, and the yield drops to 3.9%?
Wouldn’t it make sense to sell my Aviva shares, and put the profit into a different high-yield stock that I now think is better value?
Right now, some of my top dividend yields are from financial stocks. In a few years, a different sector might be out of favour and great value.
The rational thing to do is surely sell those stocks whose value is out, and buy the new top-value high-yield ones.
It’s still LTBH
I’m not going against the long-term-buy-and-hold (LTBH) strategy. No, LTBH has never meant “…hold, no matter what changes“.
Even the best known long-term investor, billionaire Warren Buffett, can be quick to sell when he sees a stock that’s better value.
So, buy stocks I’d want to hold for 10 years. But always look out for better value. That’s how I aim for maximum second income.
