10 shares to give you a £10,000 annual income in 2021

The investable universe for income seekers shrank in 2020, but these stocks are great dividend payers.

Enough has been written about the impact of the pandemic on global stock markets. A year of two halves is how 2020 will be remembered for many businesses and industries. And it was no different for our income portfolio designed to generate £10,000 of annual income.

Six constituents within the 2020 portfolio generated significantly less income than expected. Two of those – Lloyds Banking Group (LSE:LLOY) and Hays (LSE:HAS) – paid nothing at all. That meant annual income received from the 10 portfolio stocks was just under half the £10,000 predicted at the start of the year. Rather than a 6.38% yield, it was more like 3.35%.

• Invest with ii: Top UK Shares | Share Tips & Ideas | Open a Trading Account

Capital declined too. It cost £157,000 to build the portfolio, but once the pandemic had done its work, the value was just over £124,000, a decline of 20.9%. In normal circumstances, an investor would typically be invested for the long term. After reviewing the quality and potential of stocks within their portfolio, most would take this hit on the chin, maybe make a few tweaks here and there, but stick with stocks for the long term.

• 10 shares to deliver a £10,000 annual income in 2020
• Cheap UK shares at massive discount to US peers
• Six value share tips for 2021 – and beyond
• What Bill Ackman thinks will happen to stocks in 2021

But this is a 12-month portfolio, designed as a vehicle for analysing the thought process followed when building an income portfolio. It also gives a great opportunity to assess the income-generating qualities among stocks of the day. 

After running through the heroes and villains of last year’s portfolio, I’ll reveal who gets a second chance in the 2021 portfolio and which stocks are punished for underperformance. To achieve the £10,000 of dividend income for the year, the final portfolio of 10 stocks offers a prospective yield of 6.5% for a total initial investment of £160,000. 

Heroes and villains of the 2020 income portfolio

Sainsbury’s (LSE:SBRY) and United Utilities (LSE:UU.) were the two constituents that did exactly what they were chosen to do last year. Both delivered a slightly better-than-expected yield of 4.6% while still preserving capital.

GlaxoSmithKline (LSE:GSK) has come in for some stick in recent years, and there have been doubts about sustainability of the dividend. But the drug giant repaid our faith last year, also generating a yield of 4.6%. Unfortunately, the share price fell 20%. 

Rio Tinto (LSE:RIO) came in about £120 short of the income we wanted. However, in the circumstances, it is difficult to be upset with a yield of 6.7%, especially when the share price soared 38%. In a greedy mood, we picked Persimmon (LSE:PSN) for its 8.7% dividend yield. We ended up with a still respectable 4% yield and 3% share price gain. 

Three high-yielding big guns – BP (LSE:BP.), Imperial Brands (LSE:IMB) and Aviva (LSE:AV.) – produced more modest dividend yields of 4.9%, 3.5% and 3.1% respectively. In current times, that looks attractive, but not in January 2020. Share prices were down sharply too – BP fell 42% as the economic collapse hit oil prices, Imperial lost 19% and insurer Aviva fell 17%.

We’ve already called out Lloyds - hit hard when banks were banned from returning cash to shareholders - and Hays, which scrapped the dividend completely and also suffered share price declines of 41% and 16% respectively. 

A new portfolio for 2021

Like a football team that fails to live up to expectations, there’s a big clear-out at the top for the 2021 income portfolio.

Aviva, Hays, Imperial Brands, Lloyds Bank and Persimmon lose their places. All are good companies, but either dividend prospects remain unconvincing, or they come second-place to more attractive peers. GlaxoSmithKline is removed too. That’s a tough decision, but it will likely trim its generous payout, and we just don’t know by how much.

• Mark Slater: why cheap UK market is a buy in 2021
• A new commodities supercycle: mining stocks in demand
• The 31 top value stocks for 2021

The four ‘keepers’ are BP, Rio Tinto, Sainsbury’s and United Utilities. The final three of this group are rewarded for their consistency last year and more stable dividend outlook. Oil giant BP should benefit from a recovery in oil prices, as vaccine rollouts underpin economic recovery and oil demand. 

Six new faces

What a mistake it was replacing Legal & General (LSE:LGEN) with Aviva in 2020. A year earlier, L&G had delivered a 7.3% dividend yield and 34% increase in the share price. By year-end the yield was a more modest 5.8% and I thought the shares had run out of puff. They hadn’t. Not only did L&G maintain the dividend in 2020, the shares outperformed rivals. A new and viable dividend policy should see the current attractive payout maintained, so L&G is back in squad. 

I’m bringing in M&G (LSE:MNG), too. The investment manager is already one of my ‘speculative’ income ideas for 2021, and a modest consensus yield of around 7% is hard to resist. Annual results in March might bring a reassessment of the payout policy, but it’s hard to see a significant reduction in returns. 

I’ve also backed both Diversified Gas & Oil (LSE:DGOC) and AEW UK REIT (LSE:AEWU) previously this year, but prospective yields above 9% make the pair an obvious choice for the higher-risk element of this income portfolio. 

Diversified Gas & Oil chiefs told me recently that the dividend and the payout ratio is “non-negotiable”. It also makes good money and improves margins which produce cashflow to pay the generous dividends. Reliability is also attractive at regional UK commercial property assets owner AEW UK REIT. Its net asset value has held up well through the crisis and rent collection speed continues to improve.

• Six speculative UK share ideas for 2021
• Stockopedia: 10 large-cap dividend shares set to grow payouts
• Take control of your retirement planning with our award-winning, low-cost Self-Invested Personal Pension (SIPP)

National Grid (LSE:NG.) wins a place in this year’s portfolio. There is a degree of uncertainty around the new five-year regulatory framework for its UK energy business, and it might be that a restructuring causes changes to the dividend policy. However, that seems unlikely, and it is worth the gamble. It will be late February at the earliest before we know more.

British American Tobacco (LSE:BATS) concludes this year’s new additions. It remains committed to paying out 65% of adjusted earnings as dividends, so expect 215.6p in 2021, giving a yield of over 8%. Many BAT followers are also optimistic about prospects for better growth in so-called next generation products, or NGP, like e-cigarettes.

Source: SharePad, analyst estimates. All figures as at 12 Feb 2021.