Image source: Getty Images
When targeting passive income, investors typically look at dividend yields first. That makes sense: the yield offers a quick indication of how much annual income a share may generate relative to its price.
Yet focusing on that single figure can be a costly mistake. A high yield may reflect a generous, well-funded payout. But it may also signal that the share price has fallen because investors are worried about the business.
I think the difference matters. Passive income’s supposed to be dependable, so the quality of the dividend deserves as much attention as its size.
There’s several reasons that income investors need to look beyond just the yield. At times, a company’s results may even appear encouraging, but that doesn’t mean the dividend’s guaranteed
So what should investors examine before buying a high-yielding share? The answer starts with understanding the business behind the dividend, not simply admiring the percentage on a screen.
Legal & General as an example
Legal & General‘s (LSE:LGEN) often a top choice by income investors because of its high yield, backed by a wide range of financial services and products. Its businesses include retirement solutions, insurance and asset management.
That diversification makes the shares appealing to investors looking for a substantial income stream from a familiar UK company.
The latest half-year results gave supporters some positive evidence. Core operating profit rose 7% to £918m, while core operating earnings per share (EPS) increased 11% to 12.15p. It also increased its 2026 interim dividend by 2%, from 6.12p to 6.24p per share. The increase is in line with its guidance for 2% annual dividend growth during 2025-2027.
Meanwhile, it expects 2026 core operating EPS to be above the top end of its 6%-9% target range. All that should help instill confidence in any investors considering the stock for income.
Still, that doesn’t make the stock risk-free.
Why the yield could be a trap
The first risk is dividend cover. Yes, the earnings growth’s impressive, but L&G still needs to pay out a huge amount in dividends. If earnings weaken, it could struggle to meet dividend payments without using cash or debt. Investors should therefore compare the dividend with earnings, cash generation and capital requirements rather than assuming that any payout’s guaranteed.
The second risk is business-cycle exposure. Financial companies can be affected by market conditions, interest rates, competition and changing demand for retirement products. A strong half-year doesn’t ensure that every future period will be equally favourable.
Finally, there’s share price risk. Even if L&G maintains its dividend, a falling share price could wipe out any dividend income. For example, a 7% price decline would negate any returns from the 7% yield – and that’s before tax.
The bottom line
Since I’m a shareholder, I clearly think Legal & General’s worth considering. But this example exhibits what needs to be looked at before making any decisions. Always examine dividend cover, balance sheet strength, earnings trends and valuation.
In an adequately-diversified portfolio, the inclusion of more stable stocks helps smooth out other sector-specific risks. Sometimes, a lower-yielding share with steadier growth can ultimately deliver better passive income if the payout keeps rising and its share price proves less vulnerable. That’s why the biggest yield isn’t always the safest income – unless it’s sustainable, it could be a dividend trap.
What income stock do we like better than Legal & General Group Plc right now?
One of our Share Advisor analysts has just released a brand new stock report that we think is a must-read for any investor looking to try and generate potential income.
And the best bit is that you can see if for yourself, right now, absolutely free of charge!
No jargon. No hard sell. Just a clear look at an income share we think is worth your time.
Mark Hartley owns shares in Legal & General.
Image source: Getty Images
When targeting passive income, investors typically look at dividend yields first. That makes sense: the yield offers a quick indication of how much annual income a share may generate relative to its price.
Yet focusing on that single figure can be a costly mistake. A high yield may reflect a generous, well-funded payout. But it may also signal that the share price has fallen because investors are worried about the business.
I think the difference matters. Passive income’s supposed to be dependable, so the quality of the dividend deserves as much attention as its size.
There’s several reasons that income investors need to look beyond just the yield. At times, a company’s results may even appear encouraging, but that doesn’t mean the dividend’s guaranteed
So what should investors examine before buying a high-yielding share? The answer starts with understanding the business behind the dividend, not simply admiring the percentage on a screen.
Legal & General as an example
Legal & General‘s (LSE:LGEN) often a top choice by income investors because of its high yield, backed by a wide range of financial services and products. Its businesses include retirement solutions, insurance and asset management.
That diversification makes the shares appealing to investors looking for a substantial income stream from a familiar UK company.
The latest half-year results gave supporters some positive evidence. Core operating profit rose 7% to £918m, while core operating earnings per share (EPS) increased 11% to 12.15p. It also increased its 2026 interim dividend by 2%, from 6.12p to 6.24p per share. The increase is in line with its guidance for 2% annual dividend growth during 2025-2027.
Meanwhile, it expects 2026 core operating EPS to be above the top end of its 6%-9% target range. All that should help instill confidence in any investors considering the stock for income.
Still, that doesn’t make the stock risk-free.
Why the yield could be a trap
The first risk is dividend cover. Yes, the earnings growth’s impressive, but L&G still needs to pay out a huge amount in dividends. If earnings weaken, it could struggle to meet dividend payments without using cash or debt. Investors should therefore compare the dividend with earnings, cash generation and capital requirements rather than assuming that any payout’s guaranteed.
The second risk is business-cycle exposure. Financial companies can be affected by market conditions, interest rates, competition and changing demand for retirement products. A strong half-year doesn’t ensure that every future period will be equally favourable.
Finally, there’s share price risk. Even if L&G maintains its dividend, a falling share price could wipe out any dividend income. For example, a 7% price decline would negate any returns from the 7% yield – and that’s before tax.
The bottom line
Since I’m a shareholder, I clearly think Legal & General’s worth considering. But this example exhibits what needs to be looked at before making any decisions. Always examine dividend cover, balance sheet strength, earnings trends and valuation.
In an adequately-diversified portfolio, the inclusion of more stable stocks helps smooth out other sector-specific risks. Sometimes, a lower-yielding share with steadier growth can ultimately deliver better passive income if the payout keeps rising and its share price proves less vulnerable. That’s why the biggest yield isn’t always the safest income – unless it’s sustainable, it could be a dividend trap.
What income stock do we like better than Legal & General Group Plc right now?
One of our Share Advisor analysts has just released a brand new stock report that we think is a must-read for any investor looking to try and generate potential income.
And the best bit is that you can see if for yourself, right now, absolutely free of charge!
No jargon. No hard sell. Just a clear look at an income share we think is worth your time.
Mark Hartley owns shares in Legal & General.
