Dividend payments will take a long time to recover

The dividend drought is easing. Companies that suspended dividends at the peak of the crisis are slowly resuming payouts. Housebuilder Bellway was the latest to do so this week, when it reported strong results showing a solid recovery in sales. Real estate investment trust British Land announced a fortnight ago that rent collection rates had risen to 69% and that it plans to restore a semi-annual dividend (previously it paid quarterly). Others, such as drinks firm Diageo, which was seen as a possible cutter, will keep payments unchanged, while defence group BAE Systems last month paid the final dividend it skipped in June as a special interim dividend.

In the short term, the cuts remain painful. Third-quarter dividends from UK firms were down 49% on the same period a year ago, according to the latest report from shareholder registrar Link. That was an improvement on the second quarter (down 57%), although since many of the restored dividends that now being announced will only be paid at the start of next year, the fourth quarter won’t be significantly better. Overall, Link forecasts a drop of around 45% in dividends for the whole of 2020, but holds out the hope of some improvement in 2021.

A slow recovery beckons

How much hope we should have is unclear. Link reckons that the best-case scenario for the next year is a 15% rise; the worst-case is a 6% gain. In both scenarios, companies would be paying around as much as they did in 2012. FTSE 100 dividend futures – derivatives based on the value of dividends that firms declare each year – imply only a modest further rise in 2022, reinforcing the fact that part of the drop is a cut in unsustainable dividends that will not be reversed. The outlook will depend greatly on a few sectors and a few big payers, notably the banks. These normally account for almost a fifth of dividends and I’m sceptical that these will be restored fast, since the prospects of a strong economic recovery are diminishing with every round of government incompetence. Mining, and oil and gas – which are the second- and third-largest sectors – will not raise payouts much until there is a sustained increase in commodity prices.

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So while many firms will offer good prospects as they resume dividends – either for income or for capital gains as other investors re-embrace them – it seems prudent to invest gradually (see below). The banks don’t appeal to me much, but I’m slowly buying oil (BP and Royal Dutch Shell) and mining (BHP and Rio Tinto) as well as real estate (British Land and Land Securities), and planning to take between six months and year to build up a full position in each case.

I wish I knew what pound-cost averaging was, but I’m too embarrassed to ask

There are many concepts in investing that sound far more complicated than they are. Pound-cost averaging – also known as drip feeding – is no exception. It simply means investing a sum of money into the market at regular intervals rather than in one go. So if you have £1,200 to invest this year, you might invest £100 per month. If you have £12,000, you invest £1,000 per month.

The advantage of investing this way is that it may reduce the risk (and pain) of buying just before the market drops. If you put all your money in UK shares this month and the FTSE 100 drops steadily over the next year to end up down 30%, your portfolio is also down 30%. If you invest equal amounts monthly, you are buying at a lower price each time and reducing your average cost. Your portfolio may end the year down by around 15% rather than 30%, which may make it easier to hold your nerve and wait for the recovery.

Obviously, if markets rise rather than fall over the time that you are averaging your investments, you will make smaller profits than you would if you invested a lump sum at the start. Critics point out that most major markets have risen substantially in the last few decades, and so studies show that consistently following a pound-cost averaging strategy has not delivered the best long-term returns. (It might do better than lump-sum investing if the market declines steadily over the long term, but the best outcome in that case would be not to invest at all.)

However, the behavioural benefits of pound-cost averaging means that it can be useful, especially during a crisis. Whether it ultimately produces better returns than investing a lump sum will depend on if you begin closer to the start or end of the crisis, but a disciplined approach to investing small amounts can help overcome the inertia and fear that might stop you entering the market at all until the best of the recovery is over.