Stuart Lamont, Assistant Director – Investment Management at Brewin Dolphin, discusses why investment income isn’t just about dividends.
“Many investors have seen a sharp fall in dividend income over the past year, as companies shored up their balance sheets to weather the impact of the Covid-19 pandemic.
“Over the 12 months to March 2021, UK dividends declined by 41.6% as two-thirds of companies cancelled or reduced payouts, according to research by Link Group. For those who rely on dividends to deliver income in retirement, it has been an especially worrying time.
“Yet the fall in dividend income needn’t be as concerning as it may seem. Taking a ‘total return’ approach to investing could offer far more flexibility when it comes to funding your retirement. On a ‘total return’ basis, many investment portfolios have held up well.
Investing for income
“There are two ways to make money from investments: through a capital gain as its price increases, and through dividends or interest.
“Many investors seek to draw income from dividends alone and leave their capital intact. The argument is that this reduces the risk of running out of money in retirement, allows them to pass on wealth to future generations, and avoids having to sell investments that have fallen in value.
“However, over the past few years, it has become increasingly difficult to generate a high income from dividend-paying investments alone, and this has been exacerbated by the pandemic.
“Another option is to take a ‘total return’ approach, where you combine dividend income with capital gains. When it comes to generating income, you essentially view dividends, interest and capital gains as the building blocks of your income stream.
Danger of relying on dividends
“The pandemic has shown that relying on a slice of company profits to provide an income stream can be risky. Income from dividends is not guaranteed, and it can be volatile.
“An investment with the highest dividend yield won’t necessarily be the best investment. Dividend yields are calculated by dividing the dividend per share by the price per share. If the price of the stock falls and the dividend remains the same, the dividend yield will rise. Yet a falling stock price could indicate the company is in distress.
“Dividend yield is just one of many factors to look at when assessing a stock or fund’s investment case. Sometimes, a stock might have a high dividend yield which is not sustainable. If it is forced to cut its dividend, this could result in its share price plummeting, meaning you could be hit with a double whammy of a capital loss and lower dividend income.
Benefits of total return
“Taking a total return approach enables you to construct a portfolio from across the whole investment universe, and choose investments that are expected to give the best overall performance. With a total return approach, you’re more likely to base your decisions on which investments are suitable for your individual circumstances and are in line with your capacity for investment risk.
“The main risk of using a total return approach is being forced to sell investments that have fallen in value. However, the intent is that by investing across a broad range of investments, as opposed to just income-producing ones, this will enhance your portfolio’s overall returns and reduce volatility.
“A wealth manager like Brewin Dolphin can help you maintain a diversified portfolio of best-in-class investments that suit your individual needs and goals. We can also help you build a solid financial plan that lets you enjoy life now without worrying out running out of money later.”
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The value of investments, and any income from them, can fall and you may get back less than you invested.
Neither simulated nor actual past performance are reliable indicators of future performance. Performance is quoted before charges which will reduce illustrated performance. Information is provided only as an example and is not a recommendation to pursue a particular strategy.
Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness. Opinions expressed in this publication are not necessarily the views held throughout Brewin Dolphin Ltd.