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Last week, the Bank of England raised interest rates to 1.25%. Even though it hasn’t been passed through my bank to my checking account, I can get a cash ISA rate of over 1%. With projections that the interest rate could rise further this year, some might think it’s just worth saving excess cash in high-interest accounts. Personally, I still think investing in income stocks is my best bet. Here’s why.
Higher risk, but higher reward
I accept that investing in shares involves a risk for my capital. There is no guarantee that if I invest £1,000 today I could withdraw the same amount of money a year from now. With a high interest savings account, I am guaranteed the security of my money.
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Yet, on the other hand, I think the reward of investing in income stocks easily outweighs the risk. Right now, I can buy stocks with dividend yields above 10%. While I want to stick with conservative names, I can note the 4.73% yield of Lloyds banking groupi.e. the yield of 6.08% of Vodafone.
The longer I hold these shares, the lower the risk associated with my initial investment. For example, I could buy a stock with a yield of 5% and hold it for five years. At the end of this period, even though the stock price has fallen by 10%, I am still comfortably profitable given the passive income received.
The need to diversify
Dividends are not guaranteed. This is another reason why I might decide to invest in a product like a Cash ISA, which guarantees my income. However, if I diversify my money between several different dividend stocks, I can reduce this risk.
For example, with a dozen stocks in my portfolio, I can survive if the dividend payment is cut. It’s still not what I want, but my overall income stream won’t be materially impacted. I can also sell those stocks and replace them with another company that I believe will provide more sustainable dividends. This process can be completed very easily and quickly, reducing the hassle.
So while I may need to make changes to my portfolio over time, I don’t see that as enough of a downside to justify me avoiding stocks altogether.
Long-term revenue shares
The last point that I think is really valid is my time horizon. Interest rates may rise further this year, but what will happen in the years to come? If the UK goes into recession next year, the base rate could actually go down.
Dividends from income stocks will also vary in the future. But I think the yield differential over my cash account will still be high. In other words, I don’t think there will be a time when the interest rate will be higher than the average dividend yield of my portfolio. As this gets worse in the long term, I want to continue investing in this strategy.