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Relief for income-seeking investors

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9 May 2019

David Prosser explains why it’s not all doom and gloom for investors focused on dividends.

It’s not all bad news for savers and investors in need of income. It’s true that interest rates remain stuck at bargain basement levels, with the financial markets predicting just one increase before the end of 2021; and while the Bank of England said in early May that rates could rise more quickly, it isn’t predicting anything dramatic. On the other hand, UK companies are continuing to pay their shareholders record amounts of dividend income.

In the first three months of the year alone, UK stock market-listed companies paid dividends worth £19.7bn to their shareholders according to Link Asset Services. That was a 16 per cent increase on the same period of 2018 and an all-time record for the first quarter.

Some of the money came from special, one-off dividends paid by companies following big corporate events such as the sale of a business. Mining company BHP, for example, made a £2.6bn payment. But more conventional dividends – the income that companies pay every six months - also increased by more than 5 per cent.

The stock market trumps cash

This isn’t a sudden spike. Dividend pay-outs have now increased in every year since the financial crisis of a decade ago – and Link Asset Services predicts further growth over the rest of the year. So much so that dividend payments from UK companies could break through the £100bn barrier for the first time this year.

In other words, while the income you can earn on cash savings has been pitiful ever since policymakers slashed interest rates to protect the economy in the aftermath of the financial crisis, the stock market has paid investors more handsomely. There’s a price to pay, of course: stock market investment requires you to accept the risk of your capital falling in value as well as rising, which isn’t a concern with cash.

That said, investors in cash have still lost money over the past decade. Banks and building societies have paid so little interest on savings that inflation has risen more quickly than the value of cash in the bank. In real terms, cash savers are worse off than they were 10 years ago.

How to manage risk

Stock market investment isn’t appropriate for everyone. If you can’t afford to tie your money up for an extended period – say at least five years – and might need access to it as short notice, shares don’t make sense. The danger is that you won’t have time to ride out the short-term ups and downs of the market.

However, if you do have a pot of cash from which you’d like to generate income over the medium to longer term, there are many ways to mitigate some of the risks of stock market investment.

In particular, an investment company has important advantages. You pool your money with the money of other investors in a fund that is then managed by an investment professional on your behalf. This pooling effect makes it possible to diversify your investment over many different shares – potentially dozens in many investment companies – rather than putting all your eggs in one basket.

In addition, unlike other types of fund, investment companies are legally allowed to smooth out income payments over time. In good years for dividend earnings, they can keep back some of the money they receive in order to fund payments during tougher times. This gives you access to a more predictable stream of income over the medium to longer term. Some investment companies have raised their income payments to investors every year for decades.

Investment companies do rise and fall in value over time, in line with the stock markets in which they invest. But you can even smooth out this effect with a regular savings plan, drip-feeding cash into your fund each month. This can flatten the ups and downs of the market, because in down periods, your fixed monthly investment buys a bigger holding in the fund, which then jumps ahead when returns improve.

 

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