If you are someone who concentrates on the rising and falling prices of the assets you invest in, it is easy to miss the crucial second part of the equation; dividends and interest payments.
Many companies make cash payments to their investors on a regular basis as part of their business strategy, and these dividends can have a significant effect on investment performance. Bonds and government debt, too, pay regular income to investors, a major reason why they are a component of diversified balanced portfolios.
Not all companies pay dividends, with pay-outs particularly concentrated in sectors that generate a lot of cash, such as tobacco, pharmaceuticals, banking and finance and some retailers. And there are many reasons why a company might not have a dividend strategy, including if they are ploughing all of their money into research and development, or if they are having a tough time making a profit.
The Covid cash crisis
Since the beginning of the Covid-19 crisis, many companies have cut their pay-outs to shareholders after running into trouble. The most recent report from financial administration group Link - out last week - showed that UK dividends fell 44 per cent last year, with two-thirds of companies cutting or cancelling their dividends between Q2 and Q4 of 2020.1
Some of the big names that have cancelled their pay-outs are components of many investment portfolios and pension funds, including Lloyds Bank, Barclays, Shell and Rolls Royce.
Link’s research suggests that the UK has been more affected than other areas of the world by dividend cuts, with Susan Ring, CEO of Corporate Markets at Link Group, saying that she does not expect dividend pay-outs to reach previous highest until “2025 at the earliest, and potentially even a year or two after that.”
Why dividends matter
Ring, at Link, describes the income cuts “as a dreadful result for UK investors, especially those for whom dividends are a major source of income”. Whether or not you are currently taking a monthly income from your investments, though, it is important to understand the impact of dividends on your investments.
A historic example from the Barclays Equity Gilt Study - Britain’s leading survey on the performance of different types of investment over time - illustrates the importance of factoring income into your investment strategy.
Reinvesting your dividends - putting the payments you receive back into your portfolio rather than taking them out to spend them - has a huge effect on returns.
Without dividend reinvestment, £100 invested in UK equities at the end of 1899 would be worth just £193 today, adjusted for inflation. With pay-outs reinvested, that figure jumps to £35,790 in real terms, according to Barclays.2
That’s because of the miracle of compounding, which Einstein called the eighth wonder of the world, whereby the growth of investments on investments snowballs over time.
So whether or not you rely on your investment to give you an income now, or hope to do so in the future, keeping an eye on dividends is vital for portfolio growth.
What investors can do now
Dividend cuts are a reality across the board in the UK, but skilled investment professionals are still creating income-producing portfolios using their knowledge of markets in the UK and overseas.
There are a variety of strategies to do this, and the assets used will depend on individual situations and tolerance to risk, while investment professionals also take into account the ability of companies to pay out dividends based on their financial health, looking at their cash position and a measure known as ‘dividend cover’, to show whether they can afford cash pay-outs.
Some sectors of the market are expected to reinstate dividends sooner than others, with Link singling out the banks as some of the first companies to restore dividends in 2021. An IFA can help to ensure your portfolio is managed to make the most of what is available and position your assets for an income recovery.