Looking for dividends?

All too often, news coverage of interest rate movements misses the mark. Reports about hikes in rates prompt discussions about the impact upon mortgage borrowers; that’s understandable of course, but for large swathes of the population, the prospect of higher rates is actually very welcome. They don’t have outstanding mortgage debt and they’re desperate to return to an era when savings and investments generated an income that matched or even exceeded inflation, protecting the real value of their money.

In that context, the unveiling in recent days of the latest Association of Investment Companies’ dividend heroes list offered some much-needed good news. Just as the prospect of higher interest rates appears to be receding – the Bank of England said this week that rates were nearing the peak – the list is a reminder that there are still reliable sources of income out there.

Note that word reliable, however. The 18 dividend heroes are the investment companies that have raised their dividends in each and every year for at least the past 20 years (it includes eight funds that have done so every year for 50 years or more). That doesn’t necessarily mean these funds are offering an especially high income right now; in fact, were you to buy their shares today, you’d be getting a yield of less than 5% in most cases.

Indeed, many of these funds will actually be paying out less income than they could theoretically afford to offer. An investment company, uniquely among collective funds, has the right to withhold up to 15% of the income it earns on its portfolio of investments each year; this money goes into a reserve pot that can be used to subsidise dividends for investors in lean years.

The question income-seeking investors need to ask themselves here is what they really need from their investments. Are you looking for the highest possible yield currently available, even if it’s unsustainable – or worse, puts your capital at substantial risk? Or are you looking for dependability – an income stream that allows you to plan your finances with a degree of certainty?

Certainly, there will be people who fall into the former group, particularly given the still very high levels of inflation in the UK right now. The second group, however, is likely to be a larger one. What most of us want as we think about our finances in the years to come is as much visibility as possible. We want to chart a course for the future on the basis of a detailed map, rather than opting for a scenic looking road today that turns out to be a dead end.

Investment companies, in that case, have much to offer. There’s no absolute guarantee that the dividend heroes will keep increasing their payouts, but the fact these funds have been able to do so though thick and thin in the past certainly offers comfort. They even made it through the Covid crisis, when UK dividend payments crashed disastrously, without having to disrupt their track records.

One final thought, however. The amount of dividend income you’re entitled to earn each year with no liability to tax is about to fall sharply. It’s £2,000 a year right now, but that drops to £1,000 from 6 April, and then to just £500 from the beginning of the 2024-25 tax year. For this reason, think about making good use of your annual individual savings account (ISA) allowance. All income (and profits) on investments held inside your ISA will be tax-free.