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Normally, any investment offering this type of income is likely to be a scam but this is not the case here. It does involve taking on a higher degree of risk, though, by investing in the shares of individual FTSE 100 companies.
Most of the businesses listed on the UK’s index of blue-chip stocks reward investors by giving them regular cash payments known as dividends, which investors can take free of income tax using their £20,000 Stocks and Shares Isa allowance.
Companies are handing investors a share of their profits, with dividends typically paid on a quarterly basis, plus the option of a “special” dividend on top if the company has a particularly good year.
Unlike savings interest, dividends are not guaranteed, but can be cut, suspended or scrapped if company profits fall.
For example, during the Covid pandemic almost half the companies on the FTSE 100 suspended their dividends, although others continued paying them.
Most have now restored their payouts, and the average stock on the index currently yields 3.53 percent.
Some pay a lot more than that, notably global mining giant Rio Tinto and housebuilder Persimmon, which at time of writing yield 12.95 percent and 12.44 percent respectively. These are incredible rates of income.
Both are solid, reputable companies but buying an individual company’s stock will always be risky, says Keith Bowman, equity analyst at Interactive Investor.
Rio Tinto is a £78 billion Anglo-Australian multinational and the world’s second-largest metals and mining corporation, after BHP Group.
Commodity prices can be volatile, and while they rocketed as pandemic lockdowns eased, prices have dipped as global recession fears grow, Bowman warns.
Rio recently announced it was cutting its latest interim dividend from $3.76 to $2.67. “Despite that, analysts are still forecasting a yield in the region of 10 percent this year.”
Slowing house price growth is impacting on Persimmon, whose recent trading update showed a drop in property completions and revenues, although profit margins rose. “The cost of living crisis and rising interest rates could hit demand for its homes.”
Analysts continue to forecast a future dividend yield in the region of 12 percent, Bowman adds. “This is highly attractive but could be unsustainable if we hit a recession and house prices slow or fall.”
When buying shares, your capital is not guaranteed. Measured over 12 months, Rio Tinto and Persimmon’s share prices have fallen by 18.84 percent and 35.20 percent respectively.
Investors should aim to hold stocks for at least five to 10 years, to give the business time to recover from any setback.
They must also accept the risk that the company could go out of business altogether, with no compensation for shareholders.
You can reduce your risk by investing in a spread of companies, and plenty more FTSE 100 stocks offer attractive yields.
Bowman highlights tobacco company Imperial Brands, which yields 7.45 percent and insurer Aviva, which yields 8.21 percent.
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There are many more top FTSE 100 stocks to choose from, for those willing to take on the extra risk of buying direct equities.
However, do not simply buy those offering the highest yields, as these may be unsustainable over the longer run.
Typically, most FTSE 100 stocks yield between 3 percent and 6 percent a year, including household names BT Group (4.88 percent), (Glaxo (4.54 percent), Tesco (4.14 percent), Unilever (4.55 percent) and Vodafone Group (6.26 percent).
Just remember that dividends can both rise and fall, depending on economic conditions, and your capital is at risk.
Laith Khalaf, AJ Bell’s head of investment analysis, says another way to spread risk is to invest in a fund that buys dozens of income-paying stocks. “Dividends are attractive in times of economic turmoil, as they should give you a financial return whatever happens to share prices.”
He tips City of London Investment Trust, which currently yields 4.78 percent from a portfolio of UK equity income stocks, and has increased its dividend for an incredible 56 consecutive years.
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