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Putting money aside in a Self Invested Personal Pension (SIPP) can greatly improve an investor’s quality of life when retirement comes knocking. In addition to providing a tax-advantaged way to build a large pension pot, investors can use the power of dividends to build a solid retirement income.
With that in mind, let’s explore how I would aim to build an income SIPP that produces an annual yield of 7% open.
Avoid high yield stocks
Historically, the FTSE 100‘s has provided investors with an average yield of about 4% per year. This figure often fluctuates around the stock market, and currently sits at around 3.6%. However, when you choose income opportunities instead of investing in an index tracker, it is possible to own stocks that offer much more.
right now, Phoenix Group Holdings share price (LSE:PHNX) currently offers a jaw-dropping 10.5% yield. That’s more than my 7% target, so that makes it a good addition to my SIPP? That’s not the case.
It is important to remember that yields are a function of both dividends and share prices. And right now, nothing looks secure in Phoenix. The insurance titan has seen its market capitalization fall by a third over the past five years. And while profits have continued to rise during this period, there is growing concern that the gravy train may soon end.
Historically, the insurance business has grown through a niche strategy of buying/exiting life insurance contracts and letting them run. This has translated into a favorable amount of insurance premium income with smaller amounts of claims from customers.
Sadly, this strategy has brought increasing levels of growth as it becomes increasingly ineffective now that Phoenix has grown exponentially. Therefore, the management decided to completely change the strategy, which will lead to Phoenix entering into direct competition with the titans of the same industry. Aviva.
Focus on profit growth
Currently, there is growing uncertainty about Phoenix’s ability to represent the highest levels of competition. This is one of the main reasons why stocks have been sliding.
Of course, there’s always the chance that Phoenix defies expectations and continues to thrive. And if that happens, then today’s 10% yield looks like a bargain. But sadly, this is a very serious risk. And it’s one of the many high-yield share opportunities they often share.
That’s why some of the best income opportunities have not been high-yield firms but rather those with the ability to continue to increase dividends over time. Companies with proven business models that generate excess cash flow are often able to increase shareholder payouts consistently. And after many years of paying the mountains a small harvest can turn into something more amazing.
So, if I aim to achieve a 7% dividend yield in a SIPP, I will focus my money on businesses that can grow payouts over time rather than those that offer risky yields today.
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