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We are all familiar with the warnings issued by investment managers and
stock brokers. You know the sort of thing, “Shares can go down as well
as up”. (Really?). “Past performance is no guarantee of future returns.”
(You don’t say?). Health warnings aren’t just on cigarette packets and
the investment industry is going the way of Health and Safety in
warning of potentially dire consequences that may arise if you
participate in certain activities. |
They are stating the blindingly obvious and nobody in their right mind is going to put money into the stock market believing that their investment is never likely to fall in value. It is an old saw of economic theory that ‘profit is the reward for risk’ and therefore you cannot expect to make a profit (capital gain in this case) without some element of risk. The trick is to reduce the risk to acceptable levels, but of course, what is acceptable for me might not be acceptable for you. The risk element becomes far more significant once you are retired from gainful employment or you are approaching that nirvana.
Volatility is the enemy of security in the stock market battle. All investors, but particularly the amateur punter, hate volatility with a passion. Volatility causes us to buy high and sell low, when we should be taking heed of Warren Buffett’s advice to get greedy when others are fearful and get fearful when others are greedy. Capital preservation should be the mantra on the home screen of every silver surfer.
Financial concerns expand as interest rates shrink and inflation ticks up another notch whilst our buying power is reduced and volatility is potentially eroding our capital. To maintain our standard of living or, in modern parlance, our lifestyle, can only be achieved by dipping into savings or selling some investments; usually at precisely the wrong time. What to do?
The fact is that in times of low interest rates we need more income. Generating income has to be a vastly better approach than spending our capital and therefore the old stock market strategy of buying growth shares is as irrelevant as the penny-farthing. Share prices will always fluctuate, but will usually gain over the longer term and a share will never lose money until you sell it. The problem inevitably is that share prices are in the doldrums just at the time you are obliged to dispose of them to maintain your lifestyle. The answer is dividends.
Dividends are paid almost without fail every three or six months directly into your bank account and you don’t have to sacrifice any capital or sell any shares to get that income. In addition you have the greater freedom to sell shares when it suits you, so you have a much better chance of enjoying capital appreciation in addition to the dividend income. Incidentally, an even better strategy is to reinvest the dividends and enjoy the benefits of compounding and pound cost averaging, but that’s another story and doesn’t apply when you need the income to spend.
The dividend rate alone is not the only criteria and what we are looking for is a level of dividend certainty combined with a record of dividend growth from a safe and secure source. Large companies, preferably with an international revenue stream, from the FTSE 100 or 250 are therefore the order of the day. Major businesses like Tesco, AstraZeneca and Unilever spring to mind. There are also specialist funds that concentrate on dividend earning companies into which you might prefer to invest if you don’t want to be bothered with the research, but watch out for fund management charges or the spread between buying and selling units. Some fund managers will tell you that they don’t charge the normal 5% up front fee, but check the buy/sell spread and you will usually find that the 5% is encapsulated there. There’s no free lunch and fund managers have to make money like everyone else.
There is another aspect of dividend generating shares that is often overlooked and that is the reduction in our old enemy, volatility. In bear markets investors will often move out of growth stocks and into income generators thus supporting the share price. The converse is true in bull markets, but then our primary concerns are income and risk reduction and the price we pay for that peace of mind is a potential reduction in the capital gain when markets are accelerating upwards.
Websites such as The Motley Fool (www.fool.co.uk) and www.itpaysdividends.co.uk are great sources of further information on dividend investing and, no, we don’t have any connection with them.
Good luck with your investing.