Here’s how I’m investing in stocks to create a second income source!

Investing in stocks can be daunting. That’s why many people simply opt for savings accounts or Cash ISAs. But, even the best Cash ISAs are only offering around 2% returns right now. So, with inflation soaring in the UK, and possibly hitting 10% before the end of the year, I’m looking for higher returns by investing in stocks. Here’s what I’m doing!

Prioritising returns

With inflation higher than its ever been in my lifetime, I want to make my money work. That’s why dividend stocks form the core part of my portfolio.

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There are plenty of stocks offering attractive dividend yields right now and they could help my portfolio negate the impact of inflation. Persimmon offers an 11.58% dividend yield if I buy at today’s price. Another option is Rio Tinto which has a passive income offering of 11%.

In fact, according to broker AJ Bell, Rio Tinto is expected to be the FTSE 100 single biggest dividend payer in 2022, paying out £7.4bn. The broker said it expected the average index dividend yield to be around 4.1% in 2022. 

Life insurance specialist Phoenix Group, which owns household names like Standard Life and ReAssure, is another strong passive income option. If I were to buy now, I could expect a dividend yield of 8.6%.

Of course, dividends are by no means guaranteed and high yields are often unsustainable. That’s why I always look at the dividend coverage ratio. This indicates how many times a company can pay its dividend out of its net income. A yield above two is normally considered healthy.

Investing in funds

I can also look at funds that offer inflation-beating returns by investing in stocks on my behalf. Total return funds typically invest in a mix of investments including shares, bonds, commodities and currencies, and therefore can carry less risk than investing directly in stocks myself. Fund managers look to generate positive returns in a range of market environments.

The Pyrford Global Total Returns Fund is one option I’ve been looking at. The fund has three objectives. The first is not to lose money over a 12-month period. The second is to deliver inflation-beating returns over the long run. And the third is to minimise volatility. It does this by not investing entirely in stocks.

While funds are often deemed less risky, they can go down too. Scottish Mortgage, a publicly traded investment trust, is the perfect example. Despite years of good performance, it has tanked in 2022.

Value over growth

2022 has been a bad year for growth stocks. In fact, the Nasdaq, which is heavy on growth and tech stocks, has seen 22% wiped off its value this year. And it’s down nearly 10% over the last 12 months. Investors instead have turned to value. While I have some exposure to growth stocks in my portfolio, I prefer value stocks. These typically have lower price-to-earnings ratios. Meanwhile, growth stocks typically appear more expensive as they’re valued on future growth expectations.

Growth stocks have been negatively impacted by rate rises, which increase the cost of borrowing. Higher inflation and interest rates incentivise investors to favour near-term returns in the form of dividends over long-term growth prospects. Value stocks are also a much better source of dividends, and that’s another reason why I prefer them right now.