So far this summer, there has been a lot of pressure on my cash to perform. A deadly cocktail of high inflation and a cost-of-living crisis, means that I need my money to work hard for me. I have a few different options that can help to generate yield on my excess money. However, one of my favourite remains income shares. Here’s how I’d put a spare £1,000 to work at the moment.
Making sure I can afford to invest
To begin with, I want to be happy that my £1,000 is genuinely spare funds to invest. The last thing I want to do is invest it and then find out I desperately need the money at the end of the year. By needing to sell quickly, it could mean that I won’t get paid a dividend from some stocks. Further, it might force me to take a loss on my investment if the share price has fallen.
As a long-term investor, I want to leave that grand in the market for years to come. This means I benefit from future income, but also allows me to compound my gains. For example, I can take the dividends and put that money back in the company by buying more shares in the firm. Then if the dividend per share stays the same, my dividend the following period will have increased.
Taking on risk, but not too much
I’m also aware that there are some income stocks that have an eye-catching yield, but might not be my best option. As a general rule of thumb, the higher the dividend yield, the higher the risk. If a stock has an exceptionally high yield, I have to ask myself why is this the case?
For example, it could be due to the fact that the share price has crashed. In that case, it might be reasonable to conclude that the struggles in the business will see the dividend cut in the future. So I’m better off not investing right now.
This doesn’t mean that I’m going to invest my £1,000 just in companies with 1%-2% yields. But I think my ideal risk/reward level is in the 4%-7% bucket. There are still plenty of options for me to choose from, providing income comfortably above what I could get from high interest deposit accounts.
Having a mix of income shares
If I put my hard-earned £1,000 in one stock, I feel I’m taking too much risk. What happens if this business struggles due to a global downturn and has to cut the dividend to maintain internal cash flow? I’ll be stuck!
Instead, I’ll split the money between half a dozen stocks. By doing this, I give myself a much better spread of dividend potential. It also helps me to spread my risk across different sectors.
Even with my best efforts, it’s worth flagging up that no dividend share is a guarantee for income. Even with diversification, I need to be aware that at the end of the day, I could still get £0 in dividends. However, I think this risk is small, hence why I think this is a smart choice for my funds this summer.
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Jon Smith and The Motley Fool UK have no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.