Dividend investing is a strategy which focuses on buying particularly stocks (or funds) that can offer an income from the dividends.
Dividends are a payment to shareholders based upon company earnings. The regularity of the payments is up to the company. In the UK, most FTSE 100 companies pay a dividend twice a year (every 6 months). Some companies will pay every month, every quarter or once annually. Some companies also pay no dividends.
Key Dividend Dates
It’s important to know the Key Dividend Dates when investing.
Declaration date: This is the date when the company announces its dividend. Well in advance and this is legally binding.
Ex-dividend date: To be eligible to receive the dividend payment shareholders must buy the shares 1 day before the Ex-dividend date. Settlement takes 2 days so this will ensure they are on the register for record date.
Record Date: Usually on a Friday, this is the date the share register is checked for who is entitled to dividend payouts.
Payment date: Dividends will be paid on this date. Quite often it’s within 30 days of the record date, but can be longer.
The dividend yield which you will often see quoted is simply the annual dividend per share divided by the price per share. This is then expressed as a %.
According to CEIC Data & the Actuaries Share Index, the average dividend yield for FTSE 100 companies from June 1993 to November 2018 was 3.47% pa. The FTSE All Share averaged 3.52% pa from Jan 1988 to Mar 2020.
As you can see anyone planning to derive a full-time income from the average dividend yields will have to have a significant amount of money. For example, if you wanted to be earning £30,000 per year and you were obtaining the average FTSE 100 dividend yield of 3.47% you would need £864,553 invested. (*Excluding any taxes)
Calculation: £30,000 ÷ 0.0347 = £864,553
We’ve taken the average dividend yield because many top investors say that the optimum strategy for most investors is to buy into low cost index trackers funds. Such as FTSE 100 Index tracker Funds. These will pay out roughly the above figures.
This seems like a lot to most people.
The figure above changes quite quickly if you change the scenario slightly. If your savings are in tax efficient wrappers such as an ISA you might need a lower income. Lets say £25,000. If you were to pick stocks that yielded 5% instead then the figure you need is £500,000.
Calculation: £25,000 ÷ 0.05 = £500,000.
High Dividend Yield Stocks
There are many bloggers & youtubers claiming you can retire at 40 on dividend income, the above calculation would make this seem pretty difficult by anybody’s standards.
One of the methods that people suggest is buying into stocks which offer high dividends.
At the current time of writing (April 2020) there are loads of major brands offering extremely high dividend yields. A report pulled on ADVFN shows the following dividend yields. Bonmarche Holdings 91%, Eddie Stobart Logistics 73%, Galliford Try Holdings 47% & Ted Baker 39%. We are in strange times at the moment, but there are always companies seemingly offering high yields.
However, we feel that investing in high dividend stocks is highly risky.
Firstly very high dividends are unlikely to last very long. They are high for a few reasons. The usual reason for an abnormally high dividend yield is that the stock has fallen in price and the company is still going ahead or planning to go ahead with it’s dividend payment.
An example of this would be if a stock plans to pay out a dividend of 5p and the price per share is 100p then the dividend yield is 5%. If the price falls by 50% to 50p and the dividend remains the same, then the dividend yield is now 5p/50p = 10%. If the stock then halves again then the yield is 5p/25p = 20%.
So if you had invested at the start would you be happy? You might on paper have some good dividends in terms of yields coming up, but you’ve just lost 75% of your stock value!
The Risks of Dividend Investing
Companies do cancel dividends!
Recent predicaments have shown just how flawed a dividend investment strategy on it’s own can be. In March 2020 many companies scrapped their dividends for the rest of the year to save much needed cash. These include Stagecoach, Kingfisher (owner of B&Q/Screwfix) and ITV. Further companies such as Barclays lowered their dividends.
Companies also go into administration!
This highlights another major flaw of dividend investing and indeed an issue for general stock picking investment strategies. Big and small companies do go bust!
Even before the Coronavirus issue which has seen many casualties there were some big companies that went into administration. Carillion, Mothercare & Thomas Cook were just a few in recent years.
As a common shareholder the chances are you will get very little or nothing back of your investment. Once the company sells their assets common shareholders are usually last in line. Government taxes, bank loans, suppliers, bondholders and preferred shareholders all come first.
The fact that there are major shocks, goes to show how important it is to diversify your portfolio.
Dividend Investing Strategies
There are a variety of strategies and variations of each strategy. Some of the main ones that you will hear about are:
Dividend Aristocrats are companies which have increased their dividend for many years in a row. They are often large companies and you can easily find lists of these or even invest in specialised funds.
A variation of the Dividend Aristocrats the Dividend Heroes are all Investment Companies which have increased their dividends for over 20 years in a row.
Dogs of the Dow
First made famous in 1991 by the best selling book ‘Beating The Dow’. The Dow refers to the Dow Jones which is a stock market index of the top 30 companies by size traded in the USA. The strategy is to buy the 10 highest dividend yielding stocks at the start of the year, after 1 year you then switch these for the 10 highest dividend yielding stocks at that time and repeat this annually. The Dow 5 and the The Dow 4 are variations of this.
Investing in High Dividend Growth
This differs from the Aristocrats in that it focusses on companies who might not have a long dividend history or even a high dividend at the moment, but whose dividend is increasing at a fast rate.
Do Dividend Investing Strategies work?
It’s always difficult to give complete confirmation on a strategy, much depends on how each individual applies it and the time frames. One strategy that works today, may not work next year.
There have been many studies of the ‘The Dogs of the Dow’ strategy and it has been shown to slightly outperform the Dow Jones index. When it was created it was even better. A variation which slightly improves it is the Small Dogs of the Dow. According to thecollegeinvestor.com ‘The Small Dogs of the Dow returned 12.6% to investors in the last 20 years’. In the same period the Dow Jones returned 10.8%. However it doesn’t look like such comparisons include trading fees.
We can also look at the performance of funds which employ this strategy, one is called the ‘ALPS Sector Dividend Dogs ETF’. As of writing this fund is significantly down over the last 8 years compared to the S&P 500 Total Return Index.
Wikipedia has this to say about the Aristocrats, ‘over the past 10 years through the period ending March 31, 2020, the S&P 500 Dividend Aristocrat index has returned 10.98% on an average annual basis whereas the S&P 500 index has returned 10.53% annually during that same period’.
One way to look at strategies quickly is by looking at the performance of funds which focus on dividends and compare this to the funds that track the broad market such as the FTSE 100 & S&P 500. We decided to pick 4 popular Dividend focussed funds; a little about them and the results are below.
‘Seeks to track the performance of the FTSE High Dividend Yield Index, which measures the investment return of common stocks of companies characterized by high dividend yields’.
‘The fund employs a disciplined approach to investment which concentrates on the analysis and selection of individual companies. The emphasis on dividend yield helps to identify shares that are relatively cheap and to avoid those that are expensive. From the universe of high-yielding stocks, the fund manager identifies companies that are competitive, with a strong business franchise and that have attractive dividend growth prospects’.
‘Invests primarily in a diversified portfolio of equity securities of businesses located around the world that pay or are expected to pay a dividend or distribution. Exposure to these types of securities will be obtained indirectly by investing primarily in the Dynamic Active Global Dividend Fund’.
‘The Fund’s investment objective is to achieve a growing income with some capital growth over the medium term (3-5 years) by investing at least 80% in the shares of medium-sized and larger UK companies listed on the London Stock Exchange.’
Vanguard FTSE All World High Dividend Yield UCITS ETF Inc USD
‘The Fund seeks to track the performance of the FTSE All-World High Dividend Yield Index’.
|Fund||1 Year||3 Year||5 Year|
|iShares Dynamic Active Global Dividend ETF||10.70%||67.20%||–|
|UBS S&P 500 Index C Acc||2.80%||30.20%||80.10%|
|Vanguard High Dividend Yield (USA)||-5.30%||13.00%||58.70%|
|Royal London UK Dividend Growth M Acc||-14.40%||-3.50%||4.60%|
|Vanguard FTSE All World High Dividend Yield||-13.10%||-4.00%||18.60%|
|HSBC FTSE All Share Index C Acc||-17.70%||-9.30%||1.40%|
|M&G Dividend I Acc GBP||-20.00%||-20.60%||-11.00%|
It’s difficult to draw any full conclusions from the results, however there are some really stand out points to mention. The glaring point is that the iShares Dividend fund over the last 3 years performed not only the best, but twice as well as the 2nd best performing fund.
Perhaps we shouldn’t get too excited because the worst performer over the 1, 3 and 5 years was the M&G Dividend Fund.
Why did the ishares fund perform so well?
The fund may have performed so well because it has an overly heavy weighting towards health care, with it’s top 3 investments all being in this sector. All of which have done well in the current climate. It’s 4th largest investment is in Amazon which has also done very well recently. There is only 3 years of data so it’ll be interesting to see how it performs over the next few years.
S&P 500 vs Vanguard High Dividend Yield
Many dividend investors will be looking at buying a basket of high yielding funds, so a comparison between an index tracker fund and a high yield fund seems appropriate. The shock here is that the Vanguard Fund over the 1, 3 & 5 year period underperforms the S&P 500. 80% versus 59% is quite a significant difference.
FTSE Index vs High Yield
In the UK the picture is slightly different with the Royal London outperforming the FTSE All Share & M&G Dividend underperforming.
The Vanguard FTSE All World High Dividend Yield UCITS ETF Inc USD sat in the middle of the group.
So all in all we have a very mixed view of performance of selecting stocks based on dividends. It’s very likely that superior performance can be achieved, the question is how much more, is it worth the effort and the trading fees as compared to long term index tracker investments and also will it continue to work?
Dividend Investing & Tax Advantages
Even though dividend investing is a focus on income, one should still take advantage fully of tax efficient schemes. Such as ISAs and SIPPs.
For long term investing and taking advantage of compound interest by re investing profits, cutting your tax bill on profits can have a huge effect on future values.