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If you don’t buy high-yield blue chips now, you’ll likely regret it later

Back in September 2007, I concluded a series on how to roll your own income generating high-yield portfolio (HYP) of leading UK shares with an article that put together an example portfolio.

I’ve not tracked that portfolio’s performance, but I’m sure its value has fallen; we’ve been in a bear market, and high-yield dividend payers have suffered at least as much as any other shares. (The paid-for equivalent, the equity income funds, have certainly slumped.)

I’m not too bothered by that September HYP’s decline, however, for five reasons:

  • Short timescale: Six months is a ridiculously short-term in which to judge a share portfolio’s performance – come back in five years, or better ten.
  • Volatility in inevitable: There are no guarantees in stock market investing – shares can, famously, go up and down. This happen however and whenever you invest. If you’re risk averse but want market exposure, consider drip-feeding in your money, which will likely reduce your overall returns but will at least avoid you putting money in at exactly the wrong time.
  • HYPs are all about income: So far as I know, none of the 20 shares I put into my example portfolio have cut their dividends.
  • I don’t give advice: Please read my disclaimer.
  • Many blue chips are now cheap: It looks a great time to top-up the HYP.

The last point is the most crucial (aside from that disclaimer!). In my view, it’s vital to understand that bear markets are a buying opportunity. If you can’t get your head around the idea that cheap shares are good for you right up until the day you sell them, you’ll never make the money you might in the stock market.

Now, I don’t say this is easy. In my early days of investing I expected overnight gains in small caps, and would get dismayed when shares gyrated. I wanted to a stately rise, like going up the escalator to the higher realms of a classy department store.

But Warren Buffet, who is always worth listening to, puts it this way: If you expect to be a net buyer of hamburgers over the next five years, why would you want hamburgers to go up in price?

Share price rises are of course vital if you’re trading over the short-term, but the HYP approach is about getting a rising income from shares over the long-term. You shouldn’t be selling your shares unless the dividend is cut or the yield falls too low, and possibly not even then. You might well keep your shares when you retire, to supplement (or even comprise) your pension.

This mindset works a lot better if you’re still growing your funds, of course, and thus have a steady supply of new capital to benefit from market falls. While you can buy new shares out of dividend income, you’ll only make a small impact on your portfolio every year, relative to the portfolio’s size; in contrast, in the early years your salary will provide the biggest boost to your holdings.

A good time to buy a HYP?

Enough of the pep talk, what about buying dividend payers today? Well, the good news for those with some money to spare is that high-yield UK shares look pretty cheap.

The Financial Times, for instance, says the yield available on shares suggests the UK markets is cheap. And while it warns us to expect some cuts ahead, it points to 12 blue chip dividend-paying FTSE 100 shares that look particularly secure, and thus good value for income seekers:

Mr Secker says there are 12 blue chip companies where the dividend is sustainable for the next 1-2 years and where the trailing dividend yield is either already, or set to, rise above 5 per cent.

These are Vodafone, GlaxoSmithKline, BP, Royal Dutch Shell, Land Securities, Aviva, National Grid and Scottish & Southern Energy, Pearson, which owns the Financial Times, Home Retail Group, Marks and Spencer and British American Tobacco.

The first thing that strikes me is how nicely diversified a bunch of shares that is. You’ve got Telecoms, Energy, Property, Insurance, Utilities, Retail, Media, Drugs and Tobacco all in one portfolio. Add a bank (or possibly half measures split between two companies, given the current banking woes) and you’d have most of the market represented.

Remember, sector diversification is vital when choosing shares for a HYP, as is a sustainable dividend.

Personally, I’d add a few more shares to that selection if constructing a HYP from scratch right now, to ensure I had at least 15 companies in my collection. That aside, with its strong dividend cover and a starting yield of around 5% – higher than UK gilts, presently – I’d be highly surprised if that portfolio didn’t do very nicely over the next 5-10 years.

Why not read my introduction to high-yield if you’ve only just tuned into Monevator? And please do consider subscribing to this site (it’s free) to keep up-to-date on HYP prospects.

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{ 3 comments… add one }
  • 1 Niklas Smith April 20, 2008, 10:24 pm

    I found your high yield portfolio articles interesting, but you wrote in them that you were planning three more parts to the series (for a total of seven). Have these been abandoned?

  • 2 The Investor April 21, 2008, 10:58 am

    Niklas, yes, that’s a fair cop. I do intend to write more articles to round out the series.

    Basically, since then I’ve realised building a blog takes a very long time, and that writing everything at once wasn’t the ideal way to go about it. Successful blogs seem to stretch topics out, I would presume because few people look back into the archives (except the Google search engine!) It’s a brave new world.

    Anyway, I will try and get the series finished over the next few weeks, work permitting. There are vital aspects still to cover, particularly the issue of whether or not to sell shares, or to hold them through thick and thin.

    Arguably, the changes in CGT have also made a dividend strategy marginally less attractive for higher-rate tax payers who don’t use their CGT allowance, so I should try and address that too.

    Thanks in advance for your patience.

  • 3 David deSouza April 24, 2008, 1:03 am

    I agree with Niklas, all your HYP posts; including this one has been very good. Thank you.

    I very much favor the idea of a HYP as a pension instead of an annuity with massive sales commissions added on, that can not be passed on to your heirs.

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