The dividend approach

Corporate dividends can offer a way for private investors to secure a sustainable and growing income stream for those who are approaching retirement. Dane Halling tells us more.

investments

No one knows how long interest rates in the UK and around the world will stay at the current low levels. To counter this uncertainty, many are looking for safe income solutions to the interest rate ‘quandary’.

“Markets will always fluctuate, and sometimes they will ‘gyrate’ more than fluctuate!”

Corporate dividends offer an excellent way for private investors to secure a sustainable and growing income stream for those who are approaching retirement.

The beauty about concentrating on dividends is that it helps to free one up, to a large extent, from the tyranny of market fluctuations. Markets will always fluctuate, and sometimes they will ‘gyrate’ more than fluctuate!

With a dividend approach, the focus shifts decisively to the steady and growing stream of dividends flowing from a well-diversified basket of shares and income orientated funds.

Someone once asked J.P. Morgan what the market might do, “It will fluctuate,” he (allegedly) said, which reminds one of Harold McMillan’s famous line, “events, dear boy, events”, when asked what might upset his political plans.

We can neither control markets nor events, but by using a simple checklist of things to look out for when evaluating dividends, one can go a long way towards controlling the quality of the dividends from a carefully constructed portfolio of income producing, long-term assets.

But not all dividends are created equally. The best dividends flow from strong companies with sustainable competitive advantages.

They also flow from management teams with long-term track records of judicious allocation of company cashflow.

And crucially, they flow from pristine, uncomplicated balance sheets, the ‘engine room’ of the company.

Cash dividends provide an objective measure of a company’s value and profitability and cannot be manipulated.

It makes sense to think of these checks under two headings: reputational and financial. One is looking to invest with management groups with the very best reputations for delivering on their promises to all their stakeholders. And one is looking for companies with ample financial ‘firepower’ and a company-wide commitment to a growing dividend stream.

In an era of low rates and uncertainty about what interest rates and therefore bond yields will look over the next few years, large company dividends offer a highly-attractive ‘first-class waiting room’ for investors who require income, but who would also like to know exactly where income is derived from.

There are outstanding managers who have built their careers around dividends and the associated companies that are able to generate reliable and growing dividends.

A well-diversified portfolio (diversified by region, industry and currency) of funds overseen by these types of managers (and for larger portfolios supplemented by a basket of blue chip companies) can go a long way towards providing a steady and growing income, regardless of market ups and downs, in both the pre-retirement and retirement years.

In order to maximise the effective yield of the portfolio, it is important to keep costs to a minimum. Equities are highly cost effective if held for the long term, as once initial costs are absorbed, the dividends are ‘all gravy’, unlike funds where ongoing costs offset to a degree the dividend yield.

An adviser that specialises in investments will be able to guide and assist in these key areas (what we refer to as the: ‘what to invest in’ and ‘how to invest it’).

For investment advice, speak to a financial adviser in your area.