When I first started investing, I was completely focused on share prices. Nothing else mattered.
But I gradually realised that dividend payouts were just as important, if not more so. I saw that solid, rising dividends can make you good money – particularly if you reinvest them.
The good news is that dividend payouts today are higher than ever. Global payouts have risen by 43% over the last five years.
And last year, they broke the $1trn mark for the first time.
That’s a huge amount of money, waiting to be gobbled up by investors.
The trillion-dollar payout
I learned about the $1trn payout investors enjoyed last year from an article on income investing in Investment & Pensions Europe.
The piece quotes some research from fund manager Henderson, which took a look at where these big dividend payments were coming from.
Two points really stuck out for me. Firstly, emerging markets doubled their payouts between 2009 and 2011. The growth rate has slowed since then, but emerging markets nonetheless account for $1 in $7 of global payouts.
Secondly, technology – not traditionally a sector associated with generous dividends – has been another big growth area since 2009.
Technology dividends have risen by 109% over the last five years with Apple (Nasdaq: AAPL) playing a big part. The tech giant didn’t even pay a dividend in 2011, yet last year it accounted for roughly 17% of global technology payouts.
Companies like Apple were very reluctant to pay substantial dividends ten years ago because paying a dividend was seen as an admission of defeat. The theory was that tech companies should always be aiming to achieve high growth, and would need to invest all their spare cash in order to achieve that aim.
That psychology has changed somewhat. Big technology companies throw off piles of cash – and in a world where investors are increasingly desperate for income, shareholders are keen to get their hands on that cash. So a dividend is welcome – rather than being seen as a sign that the company is out of ideas.
Dividends can make a massive difference to your wealth
So it’s clear that there’s plenty of dividend moolah sloshing around these days – even in areas where you wouldn’t traditionally have expected it.
But what’s really important about this is that dividends comprise a huge part of the return for most long-term stock market investors – a lot more than you might expect
Look at the figures below, which come from the Barclays Equity Gilt Study 2014.
Imagine you had invested £100 in the UK stock market at the end of 1945 and sold at the end of 2013. In one scenario, you reinvested all the dividends you received. In the other, you took the dividends and spent them.
Today’s value of £100 invested at the end of 1945 in the UK stock market
Real (after inflation)
Nominal (excl. inflation)
|Dividends aren’t reinvested||£271||£9,347|
So if you reinvested your dividends, your £100 investment would have grown to £5,140 by the end of last year. That’s a ‘real terms’ figure – so it adjusts for inflation during that time. If you included inflation, your £100 would have grown to £177,620 by the end of last year.
But if you had spent all the dividends, your £100 investment would only have grown to £271 by the end of last year, after adjusting for inflation.
So it’s clear that reinvesting dividends (or ‘dividend compounding’, as my colleague Phil sometimes calls it) can make a huge difference to the size of your returns over the long term – £5,140 compared to just £271.
How to invest for income
But how do you build a portfolio that will pay out decent dividends for years to come?
One simple approach would be to invest in a FTSE 100 tracker fund. A FTSE tracker isn’t normally seen as an income investment, but the FTSE is currently on a dividend yield of 4.19%, so I think it qualifies. For now, anyway.
Another option is a ‘dividend tracker’ like the iShares UK Dividend ETF (LSE: IUKD). This exchange-traded fund invests in the 50 highest dividend payers in the FTSE 350. It’s a passive fund that focuses on the stocks with the highest forecast dividend yield for the following year. The fund is ‘rebalanced’ twice a year, and it has a fairly low management fee.
Sounds good, doesn’t it? However, there’s a problem. This particular ETF can become too exposed to one sector. I learned this the hard way myself.
I invested in this ETF back in the mid-noughties, and my investment performed well initially. However, a big chunk of the fund was invested in bank stocks prior to the crash, so the portfolio got firmly hammered in the 2008/09.
In other words, the ETF’s portfolio was too concentrated in financial stocks because they were the companies that were paying the highest yields. And it looks this problem has become an issue once again. Right now, 41% of the ETF is currently invested in the financial sector.
So buying a portfolio of individual income stocks makes more sense – as long as you make sure that you diversify that portfolio across a range of stock market sectors. Then if the banks, or any other sector crashes, you won’t be hit too hard.
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