Why do investors love equity income?

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The pull of dividend income has become a very powerful one and there is no sign of any decline in its popularity. In this short guide, we explore why companies that pay dividends are in such demand, why investment trusts are such a great way to tapinto them, and what to look for when you’re investing for income.

Ever since the financial crisis of 2008, income-seekers have had a tough time as their low-risk sources of income have been eroded. With the base rate slashed to 0. 5% in 2009, bank savings accounts offered increasingly derisory rates; meanwhile, the Bank of England’s programme of buying government bonds pushed prices up and bond yields right down.

Many people, including cautious investors who would previously have felt uncomfortable with the added risks of equity investment, found themselves looking instead to the stock market and the dividends paid out by listed companies.

Dividend-paying businesses have therefore been highly sought-after over recent years – and all the more so in the prevailing environment of sluggish, uncertain growth in most developed economies. After all, once you’ve been paid a dividend, it’s yours to keep, a real return – unlike a rising share price, which could slip back again.

But equity income has other, inherent, attractions. Not only do these businesses provide a regular income stream, but they have historically been the better-established, well-run, profitable companies with cash to spare for shareholders.

Moreover, with inflation now on the rise (CPI inflation hit 1.2%, a 25-month high, in November) people are once again thinking about how to ensure their money will hold its real value over the years. Stock market investments are very attractive in that respect, as companies tend to raise their own prices to maintain their profits when costs are rising.

Even for investors who don’t currently need an income from their investments, dividend-paying companies can work brilliantly, as reinvested dividends boost total returns enormously over the long term. That’s because those dividends are used to buy more shares, which themselves pay dividends.

To put that into perspective, according to the London Business School, since 1990 UK equities with dividends reinvested have returned 5.4 per cent a year on average. When dividends are stripped out, the average annual total return falls to just 0.8 per cent a year.

And with companies that focus on growing their dividend payouts each year, the power of compounding is even more impressive. A company that raises its dividend by just 3% a year can double its payout in less than 25 years.

So it’s hardly surprising that dividend paying companies, and the funds and trusts that invest in them, have been so popular over recent years.

 

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