Using a Stocks and Shares ISA to build an investment portfolio is generally a prudent move. While investors are limited to investing £20,000 a year, once capital has made it inside the ISA ecosystem, it becomes completely immune to capital gains and dividend tax.
With so many income stocks still depressed from the recent stock market correction, dividend yields have climbed to impressive highs. While the FTSE 350’s yield is currently close to its average, the same can’t be said for many of its constituents. And as of November, there are around 30 stocks offering a yield of 8%, or more.
With that in mind, let’s explore the best strategy to capitalise on these income opportunities and build a long-lasting, high-yield portfolio.
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8% is the target, not the starting point
At first, it may seem obvious that to achieve an 8% yielding portfolio, investors should just buy stocks offering payouts near this number. However, in reality, that could easily end in disappointment. Thirty companies is more than enough to build a diversified portfolio. But chances are quite a few of these firms could see dividend cuts in the near future.
Don’t forget that yields can be inflated by a falling share price. And the latter is typically caused by concern regarding future cash flow and earnings. Personally, I wouldn’t be surprised to see only a handful of these companies be able to sustain their current payouts. And even then, there’s the question of whether they can expand them over time.
That’s why investors could likely achieve better results by searching for income-generating businesses with the ability to grow dividends. A firm that can regularly increase its shareholder rewards on the back of expanding earnings can eventually turn a modest yield into a far more impressive one. And the end result is a high-yielding portfolio that continues to grow while remaining significantly more stable.
Diversification is key
While it’s important to carefully investigate and invest in only the best firms, diversification is still essential. That’s because even the best businesses have the potential to be disrupted. And suppose investors have all their eggs in one basket? In that case, a lucrative source of income could dry up overnight.
There are some opposing views within the investing community about how many stocks one should own. Yet most agree the magic number lies somewhere between 15 and 25.
Having said that, owning a wide range of stocks is meaningless if they all operate in the same industry. After all, if demand for metals were to suddenly drop, then a heavily concentrated portfolio of mining stocks isn’t likely to fare well.
By ensuring a portfolio has exposure to a range of sectors, problems hitting a specific industry can be offset by the success of others. And investors can take diversification even further by investing in top businesses operating in different countries worldwide.
