Buying shares can be a lucrative way to earn passive income. Even starting from nothing and putting aside some money regularly to invest in the stock market can hopefully build sizeable dividend streams. High-yield shares (those with big dividends relative to their share price) can help speed up the income-building.
But some high-yield shares can have elevated risks, while others offer limited growth prospects, or may even reflect a business in long-term decline.
If I wanted to build a high-yield portfolio with my eye on income, using a spare £95 each week, here is how I would go about it.
Yield comes last!
It can be tempting to look at a high yield and imagine just how lucrative owning a share might be. If I put £1,000 into Diversified Energy at its current yield, for example, I would be in line to earn over £300 in dividend income annually – if the payout is maintained.
The thing is, dividends are never guaranteed. Maybe Diversified’s novel model of buying aging gas wells cheaply could enable high dividends in future. But I see a number of risks, from its debt load to what happens if energy prices tumble.
Sometimes when shares have a high yield it is a red flag that the City is concerned about the sustainability of the dividend, or even the long-term health of the business.
Lots of shares with low yields have also cut their dividends over the years, so this is not just an issue with high-yield shares. But it underlines why I always begin looking for income shares by hunting for businesses with great prospects and the sort of finances I think can support large future dividends. Only if I find them do I consider their yield.
Aiming for a target second income
Still, yield matters in calculating how much dividend income I might earn. Say I invest £95 a week and reinvest the dividends (something known as compounding). If I can consistently earn an 8% yield, then I would hit my target of generating over £8,000 each year in dividends after 13 years.
Instead of building a high-yield portfolio, if my average yield was 4%, achieving the same goal with an identical weekly contribution would take me a quarter of a century.
Finding shares to buy
I could build a high-yield portfolio in my Stocks and Shares ISA. But are the sorts of shares I am looking for available? I think the answer is yes.
Consider as an example Legal & General (LSE: LGEN). This FTSE 100 company is well-established, has an iconic brand and a large customer base. It operates in the lucrative market of pensions that benefits from strong long-term demand.
Despite that, buying these high-yield shares today could offer me an 7.8% yield.
Legal & General has cut its dividend in the past and could do so again. One risk I see is any market crash leading policyholders to reduce their investments, hurting fee income.
But the company has been consistently profitable in recent years. It has signalled its aspiration to raise its dividend again next year. If I had spare cash to invest today to build a high-yield portfolio, Legal & General would be on my shopping list.
