Usually, any investment that offers this type of income is likely to be a scam but that is not the case here. It does involve taking on a higher degree of risk, though, by investing in stocks of individual FTSE 100 companies.
Most UK blue chip index companies reward investors by giving them regular cash payments known as dividends, which investors can take free of income tax using Isa’s £20,000 equity and equity allotment.
Companies offer investors a share of their earnings, with dividends usually paid out on a quarterly basis, plus the option to pay a “special” dividend on top if the company has had an especially good year.
Unlike savings interest, dividends are not guaranteed, but can be reduced, suspended, or canceled if the company’s earnings decline.
For example, during the Covid pandemic, nearly half of the companies listed in the FTSE 100 have suspended their dividends, although others continue to pay them.
Most have now recovered their payments, and the average stock in the index is currently 3.53 percent.
Some are paying much more than that, notably global mining giant Rio Tinto and home builder Persimmon, which at the time of writing produce 12.95 percent and 12.44 percent, respectively. These are incredible income rates.
Both are strong and reputable companies, says Keith Bowman, equity analyst at Interactive Investor, but buying shares of an individual company will always be risky.
Rio Tinto is an Anglo-Australian multinational with a value of £78 billion and the second largest metals and mining company in the world, after BHP Group.
Bowman warns that commodity prices can be volatile, and while they have skyrocketed as the pandemic lockdown eases, prices have fallen as global recession fears grow.
Rio recently announced that it will cut its latest interim dividend from $3.76 to $2.67. Despite this, analysts still expect a return in the region of 10 percent this year.
Slowing home price growth weighs on Persimmon, whose latest trade update showed a decline in property completions and revenue, despite rising profit margins. “The cost of living crisis and rising interest rates could damage the demand for their homes.”
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Bowman adds that analysts continue to forecast a future dividend yield in the region of 12 percent. “This is very attractive but could be unsustainable if we experience a recession and house prices slow or fall.”
When you buy shares, your capital is not guaranteed. Over the 12-month period, Rio Tinto and persimmon share prices are down 18.84 percent and 35.20 percent, respectively.
Investors should aim to hold the shares for at least five to 10 years, to give the business time to recover from any setback.
They must also accept the risk of the company going out of business altogether, without compensating the shareholders.
You can reduce your risk by investing in a corporate spread, and many FTSE 100 stocks offer attractive returns.
Bowman highlights tobacco company Imperial Brands, which produces 7.45 percent, and insurance company Aviva, which produces 8.21 percent.
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There are several top FTSE 100 stocks to choose from, for those who want to take the extra risk of buying outright shares.
However, do not simply buy the ones that offer the highest returns, as they may be unsustainable in the long run.
Typically, most FTSE 100 shares produce between 3 percent and 6 percent annually, including household names BT Group (4.88 percent), (Glaxo (4.54 percent), Tesco (4.14 percent), Unilever (4.55 percent), percent) and Vodafone Group (6.26 percent).
Just remember that dividends can go up and down, depending on economic conditions, and your capital is at risk.
Another way to spread risk is to invest in a fund that buys dozens of income stocks, says Laith Khalaf, head of investment analysis at AJ Bell. “Dividends are attractive in times of economic turmoil, as they should give you a financial return no matter what happens to stock prices.”
He is looking at the City of London Investment Trust, which currently accounts for 4.78 per cent of the UK’s equity income equity portfolio and has been increasing its dividend for an incredible 56 consecutive years.