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When considering the potential investment returns on offer for a second income, I always set a cash ISA as a benchmark. At the moment, the best easy access rate I can find is 5.1%. Since the risk of capital loss is low, alternatives such as dividend stocks should give me a higher return, given fluctuations in stock prices. Based on the current market, I think you could get a 10% return. Here is the truth.
Using the power of diversification
It may surprise some to know that there are currently five stocks in the FTSE 100 either FTSE 250 that have a dividend yield greater than 10%. You could just invest in these options and call it a day. However, five income stocks in a portfolio are not that diversified. If one of those five decided to cut the dividend, my income would drop 20%.
After all, we're talking about ultra-high-yield dividend stocks here. The risk is greater than with companies with lower performance. So, I want to try adding more to the pot. This is not impossible and, in fact, can be done quite easily.
For example, Ithaca Energy It has a dividend yield of 16.72%. He Twenty Four Income Fund (LSE:TFIF) has a yield of 9.33%. Although this is below the 10% threshold, if I invest the same amount in both stocks, my average return is 13.03%.
Therefore, I can expand my portfolio using similar companies and still have an average return of 10% even if some of the individual stocks underperform my target.
A contender to include
In terms of stocks I would include if I followed this strategy, the TwentyFour Income Fund would definitely be on the list.
I would use the stock as a sustainable dividend payer. It has a strong history of consistent payments over several years. It usually pays out funds quarterly, which I consider a positive as it saves me from having to wait an entire year to receive payment.
The fund invests primarily in asset-backed securities. As the name suggests, these are financial products that have some kind of protection attached to them. For example, a mortgage is an asset-backed security. The owner of the loan receives interest, but also has the physical property as an asset in the event of default by the borrower.
By targeting high-yield stocks, TwentyFour is able to generate good levels of income that can be paid out to shareholders on a regular basis. The share price should reflect the total value of the portfolio. Over the past year, the stock is up 8%.
As a risk, the company has exposure to areas such as student loans and credit card debt. There is a higher probability of default and therefore the company must carefully choose what to invest in.
Weighing it all
I'm not going to claim that this 10% averaging portfolio is a low risk idea. But I do think it shows that with a little imagination and research, I can make my money work harder than just putting it in a cash ISA.
