With stocks remaining depressed in multiple sectors, now could be a great time to start investing in income stocks. Because when share prices go down, dividend yields go up. And the dividend yield is always relevant to the price I pay for the stock.
This is actually a very important rule to remember. Say I bought shares in a company 10 years ago and the dividend yield was 5%. And now, 10 years later, the share price has doubled but the dividend yield is still 5%. In this case, I’d actually be getting 10% because my yield is always connected to the price I paid.
Buying in the dip
The FTSE 100 is pushing back to 7,500, and that’s been somewhat of a benchmark figure this year. The index hasn’t been above it for a sustained period of time. However, the truth is that the index is being hauled upwards by surging oil and resources stocks. In fact, stocks from many sectors are trading at considerable discounts right now.
While the general trend of the index is upwards — the FTSE 100 is approximately four times bigger today than it was 35 years ago — buying during dips can propel my portfolio forward when the market truly recovers.
So while oil, mining and a handful of other stocks are soaring, housebuilders, banks, retailers and several other sectors are not.
Generating long-term wealth
Buying in the dip is great, but if I want to generate wealth in the long run, I need to continually add to my portfolio.
I’m using a strategy called compound returns. While income stocks provide me with regular, but not guaranteed, payments, I rarely take this money to fund my life. Instead, I reinvest my dividend payments. And I add to my pot monthly.
So if I started by investing £10,000 today in income stocks paying 5% yields, and then reinvested my dividends and added just £200 a month for 30 years, at the end of the period I’d have £211,000.
That’s pretty good. But it’s also worth remembering that the index should grow over that period. In fact, using the FTSE 100’s growth history over the past 30 years, my investments after three decades could be worth closer to £500k when taking share price growth into account.
Where I’m looking
Income stocks paying large dividends aren’t hard to come by right now. But I’m looking for stocks paying a sustainable, yet handsome, yield.
I see banks as a good place to start. NatWest is down 12% over the past three months (up 2% over the year). Banks are generally cyclical and while we are entering a recessionary period, there is one big tailwind this time. And that’s higher interest rates.
So while NatWest may be down in recent months, I actually think it will perform fairly well during the recession. Net interest margins are up and revenue is surging. But in the long run, I’m also looking for steady growth, and I think NatWest can provide that.