The current difficulties and dangers faced by investors seeking income

1st September 2014 by The Harried House Hunter

Since the recovery from the global banking crisis in 2008 and apart from the odd stumble along the path investors have generally been very well rewarded for taking the risks associated with both equity and bond investment.

However, since the shocks of 2008 and 2011 investors have, quite rightly, been much more wary of returns, particularly from equity growth stocks and many investors have moved from a pure growth strategy to one more aligned to a mixture of capital growth and income.  This approach to investment is often termed a ‘real return’ strategy.  Typically this combines growth shares or funds, shares which have a dividend yield and bonds which provide a yield also.  Combined these have provided very decent returns for investors over the last few years and many investors have become used to stable and growing income levels from their portfolios which have been positioned in this way.

Over the last three years the iShare UK Dividend Exchange Traded Fund has delivered over fifty eight percent to investors versus around forty eight percent from the FTSE 100 Index of leading UK shares.

This approach appears to satisfy investors on several fronts, stable and growing income, a portfolio which nominally carries less risk than a pure equity based portfolio and which offers decent diversification over various asset classes.

Therefore, many investors have become reliant on yield but it is getting harder and harder to find.  As share prices have risen, dividend yields have fallen.  Not just for shares but also for many high-yield bonds also.  As the economy recovers high-yield, corporate and goverment bond yields are falling.  This is largely because investors are becoming more convinced that interest rate rises are not yet on the cards and therefore the long dated bonds where capital values have risen over ten per cent this year are in very dangerous territory.

Other asset classes which produce income such as property funds have also become highly crowded and yields have fallen as investors seek alternative sources of income.

All in all a bit of a perfect storm for those approaching or actually in retirement.  Particularly for investors seeking to avoid purchasing an annuity under the new incoming rules, this is now potentially posing two real issues.

Investors either need to take on more risk to continue to achieve the higher yields to which they have become accustomed or to  buy shares which do not deliver the yields required for achieving a particular income, but which should do more to protect their portfolio’s nominal capital value.

As a wealth manager, this is the type of quandary we assist clients with every day.  Our advice will always hinge around capital preservation over the longer term, particularly for those moving into retirement and who have less time or capability to rebuild capital values in the event of losses.  We counsel that it is always better to avoid too much risk and to accept less income today than have to tolerate huge losses tomorrow.

Lee Robertson is a Chartered Wealth Manager and CEO at www.investmentquorum.com

4 thoughts on “The current difficulties and dangers faced by investors seeking income”

  1. David Lilley says:

    Lee,
    I have never understood the stress on the choice between income and growth. Surely the only thing that matters is return on capital.

    1. Noo 2 Economics says:

      Income is important to people with little or no income e.g. a retired person or a younger person whom for whatever reason has little chance of obtaining employment but who has a large capital sum. They need the income/yield generated from their investment each year to live on or to help them live.

      A younger person on good pay with reasonable job security can afford to take a growth approach as they don’t need access to any of their investment in the medium term.

      Some growth investors prefer to construct an income portfolio consisting of good yielding equities and bonds allowing the dividend/yield to be re-invested back into more income equities and bonds, as when a share is bid up 10% you are 10% better off, but if shares in a company you have been rolling dividend payments into go up 10% then, assuming your dividends have purchased an extra 5% of shares then your return is 10.5% (100 shares + 5 shares = 105 shares x 10%). In this way you can find that your portfolio outperforms the Ftse as it’s performance is based purely on share values and assumes all dividends are taken as cash and not re-invested.

      1. David Lilley says:

        Noo,
        We meet again.
        I’m sorry but you are perfectly correct in your explanation but at the same time totally incorrect.
        Return on capital is the only metric. If you invest £100 in high yield or low yield the winner is the one that has the best return whether it is due to share price growth or share price growth plus dividend. You can take income from dividend or by selling shares. It is immaterial whether the stock is high yield or low.
        A high yield company is basically saying “we have made a profit and we will give it to our owners in the form of dividend”. A low yield company is basically saying “we have made a profit but we prefer to reinvest that in the business and not pay dividend because that is the best opportunity cost for your money”. “You will get a better return on your capital as the company grows and the share price grows”.
        Where is your £100 in one year’s time is the only metric.

        1. Noo 2 Economics says:

          Hallo David, I thought my previous example addressed this.

          You have 1 growth investor (A) who receives no dividend as the company he invests in re invests all profits and 1 growth investor(B) investing in dividend yielding shares and who re-invests those dividends. Both start with 100 £1.00 shares each.

          Over a year the companies of both investments make identical profits (this is an example and not real life) and as a result both shares increase by 10%, but B’s shares have paid a 5% dividend which was re-invested so B now has 105 £1.00 shares(based on the assumption the share price had not moved at time of re -investment of dividend which of course is the situation in the real world – share price may be less or more than £1.00) which then increase by 10% – £105.00 x 10% = £115.50 whereas A’s shares have increased by £10.00 – £100.00 x 10% =£110.00.

          My point is exactly yours -what is your original £100.00 worth at the end of the year?

          A further interesting phenomenon arises in the case of a market fall of 10% following a 10% increase. A’s shares fall 10% to £99.00 £110.00 – (£110.00x 10% = £11.00) = £99.00 whilst B’s shares fall 10% to £103.95 £115.50 – (£115.50 x 10% = £11.55) = £103.95.

          The gamble the growth investor takes is that as all profits are re – invested the increase in share price will outstrip the income share as some profits are paid out as income on the income shares and long term profit re-investment will be significantly less and therefore returns will be less than wit a pure growth share.

          The gamble the Growth and income investor takes is that as the market has a tangible view of the value of an income share (the declared dividend) it will likely accord the same or more value to the income share as there is more certainty around it’s value.

          So there is no “correct” or “incorrect” answer, you simply pays your money and makes your choice (or gamble). There is one fact that the average performance of the IMA income sector outperforms the average of IMA growth sector over the medium and long term and in the short term in times of market stress.

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