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Income stocks are well represented in my portfolio. Essentially, these reward their shareholders with regular, but not guaranteed, dividend payments.
By investing in these income shares, I can use the dividends to finance my life or I can reinvest them.
The latter option allows me to take advantage of something called compounding returns. This is essentially the process of earning interest on my interest.
So let’s see how it works and what actions you would choose.
mega-returns
Essentially, the compounding returns strategy is much like a snowball effect. The longer I leave it, the more money I will have in the end.
So if you were to start with £5,000 and invest in stocks that pay a sizeable, but achievable, dividend yield of 7%, after 20 years you would have £20,000. After 35 years he would have £57,000.
You could increase this bottom line by pumping in cash over time, which makes a world of difference.
If you added £150 each month for 35 years, you would end up with £327,000. If I increase my monthly contribution by 5% a year, I will have £560,000 after 35 years.
That’s the power of compounding and drip feeding.
It is important to note that the above calculation does not allow for any gain in stock price. But it’s also important to keep in mind that winnings are not guaranteed and you could lose money as well as win it.
Stock Picks
I don’t want to put all my eggs in one basket. But with £5,000 to invest, I wouldn’t split it into more than three parts. This is because I might have a hard time keeping up with stock research and developments if I were to go on too long.
So what three stocks would you choose? Well, they need to have an average dividend yield of 7% for my above calculations to work.
My first pick, and one I recently purchased, is a huge dividend payer. Phoenix group holdings. This insurance, savings and retirement business offers a solid return of 7.7% and has a dividend coverage ratio of around 1.7.
The current negative economic backdrop has proven challenging for some of Phoenix’s peers, but this company expects to generate £1.2bn of cash generation from organic and incremental new business in 2022. Shares have 13 years of consecutive payments and steady dividend growth, a big plus. .
The next thing I would buy Chemical and Mining Society of Chile. It is a booming lithium miner with a dividend yield of 7.9%. Analysts suggest that the dividend is well covered.
Of course, the stock is particularly dependent on lithium revenue, and that could be seen as a risk. Yet metal is a central component of the renewable energy revolution. I don’t see demand dropping anytime soon. That’s why I recently bought Sociedad Química y Minera de Chile.
Finally, I’m choosing Greencoat UK wind — another recent purchase of mine. The renewable energy trust aims to increase its dividend in line with inflation year on year. The stock currently offers a 5% return, which is fine, as my other two picks offer returns close to 8%. Next year, the dividend payout is expected to rise 13% to 8.76 pence per share. Dividend coverage was 3.2 times for 2022, so the increase seems affordable.
The obvious concern is that the wind can be temperamental. So until battery technology exists to deal with supply and demand issues, wind could be an unreliable source of power.
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