So, you’ve worked hard, saved prudently and now consider it necessary to start drawing from your investments or pensions.
There are two main approaches you can take, the first is to focus on investments that will pay dividends or interest, the alternative is to sell assets and also use dividends and interest i.e. total return investing.
What is Total Return investing?
Having made that distinction, let’s clarify one really important point straight away.
Imagine you own a single share valued at £100, and that share pays a £5 dividend. It can “feel” safer to just spend the £5 dividend and leave the share intact, but ordinarily once the company has paid the £5 dividend the share price will fall to £95 to reflect the distribution of profits. The value of the company has declined by £5, reflecting a dividend payment to you (shareholder).
We wish to highlight the benefits for always following a total return approach as this, we believe, can avoid some of the following problems:
Diversification
Investment portfolios built using a total return approach have the flexibility to invest far more broadly and are more diversified than portfolios that focus entirely on “income” and must therefore seek out only those investments that currently pay healthy dividends or interest.
Risk Reduction
It also leads to potential risk-reduction benefits; as total return portfolios are more diversified, by their nature they are less concentrated in a small number of assets or sectors, in which the assets themselves might be riskier in nature. For example, traditional income-focused investors have historically been overexposed to higher income equity sectors such as energy and financials, and higher yielding bond types such as junk bonds
Income control and consistency
Income from dividends can be volatile and isn’t guaranteed – for example while UK dividends rose 8% over the 2022 calendar year, they had previously fallen 42% over the 12 months to 31 March 2021 as two thirds of UK companies reduced or eliminated their dividends in response to the Covid-19 pandemic.
An income-focused investor relying heavily on dividends is highly exposed to the developments and gyrations in corporate dividend markets globally. In short, you are at the mercy of your portfolio company’s boards of directors. If your portfolio distributes fewer dividends this quarter, you’ll be spending less next quarter.
The Case for a Total Return Approach for Income-Seeking Investors
Click here to read The Case for a Total Return Approach for Income-Seeking Investors presented by Jonathan Griffiths, Investment Product Manager at EBI.
If you have a question about your investments, please send us a message via the form below or call us on 01825 76 33 66.
