Sunday 3 March 2013

Dividends are the key...

In my article keep it simple  I listed a few of my basic rules for successful investing and said I would look at each one in a little more detail.

I have been retired for a little while - well, 5 years now - and rely on the income from my investments to put food on the table and pay the bills. I think many people regard income investing as something to turn to when they are retired and in the earlier years, are better off going for growth investments.

Its true that companies which do not pay out dividends to their shareholders can use more of their profits to reinvest in the business and this should lead to faster growth of the company and therefore its share price. I can only speak of my own experience. I tried growth investing in the 1990s and my returns were very hit and miss. In more recent years, I have become a convert to income investing and find the returns overall have been better and more consistent.

Long term research into the UK market carried out by Dimson, Marsh and Staunton of London Business School, covering the period 1900 - 2010 showed that a strategy of investing in higher yield shares produced a total return annualised at 10.9% whilst lower yielding shares produced a return of 8.0%.

The study also looked at the effect of reinvesting dividends and concluded the cumulative returns without reinvested dividends were 5.0% p.a. but were 9.4% including dividends reinvested.

Research carried out by Morgan Stanley Global Equity Strategy Team in 2012, came to a similar conclusion based on studies of the US markets since 1901. They found that compound annual growth rate for equities including dividends was 9.5% compared to 4.9% return excluding dividends. The researched pointed to dividends providing the majority of the investors total return during periods when markets were range bound or falling.

Therefore, dividends are an important factor in achieving long term returns from investments. In fact, I might go as far as to suggest that investing via higher yielding investments could be the choice of long term growth investors as well as income investors.

The way I look at it is this, the average target return on my equity investments is in the region of 7% or 8% - so if I can secure a yield of 4% or 5%, I’m already more than halfway there.

I personally use a combination of individual shares and investment trust as a strategy to target income and I have set out a step-by-step guide to income in my ebook ‘Slow & Steady Steps..’. In January I wrote a couple of guest posts for RIT - here are the links to both articles 
RIT shares article  and   investment trust article

Finally, I am not suggesting dividend/income investing is the ultimate or only investment strategy. The above studies looked at returns and data spanning over a century - over shorter periods, the approach may not prove so convincing, after all, who’s going to be around in 2113 to say “There you are, I knew that strategy wouldn’t work two centuries running”!

All I know is that it seems to work for me, for now.

Leave a comment below and let me know what strategy works for you.

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