Dividends from shares almost always grow faster than inflation. And when the starting income from shares is high, as it is now, that makes them the best type of investment to protect against inflation.
Research from Fidelity shows that dividends paid by UK companies with a stock market listing grew in all but five of the last 42 years, and that in over half those years, they grew at a rate of over 10%. In most years, dividends grew at faster than the rate of inflation, as they did between 2003 and 2007.
Securing a stream of income that grows faster than inflation is a recipe for a comfortable retirement. But it’s also a recipe for accumulating a big chunk of capital when you retire. If you reinvest your dividends, then if - as now - you can get a starting income of over 5%, your capital is sure to grow at a rate of at least 5% a year, plus any increase in dividends in future years.
Predictions are pointless
I am not saying that share prices cannot fall from today’s level. But predicting the short-term course of share prices is a mug’s game. Nobody, but nobody in the 200-year history of stock markets has succeeded in doing this on a consistent basis, so my guess as to where share prices go in the next few weeks or months is as good as yours or indeed as that of most of the City’s fund managers.
There are just too many random factors involved to be consistently right with short-term predictions. But predicting the long-term path of share prices is easy. They will deliver you returns of inflation plus an average of 5% a year - that is the evidence from over 100 years of data collected by investment bankers Barclays Capital and ABN Amro.
How do you turn that knowledge to your advantage? By buying shares when you get an income return almost equal to what you can get on cash deposits or fixed interest investments. And that time is now.
Five to consider
I have chosen five investment funds that currently pay an initial rate of income of over 5%. All are run by large investment management groups; most are run by individual managers with good track records of delivering above-average returns to investors over many years.
And I have also picked five of the UK’s top 100 companies that pay high dividends. If you put an equal amount into each of these shares you will currently get a dividend return of over 7.5% on your money.
That is a much riskier strategy, because one of these companies might cut its dividend, while the five funds I have selected all hold up to 100 different shares and won’t suffer too much from any one company cutting its dividend.
Five funds for all weathers
The five funds are all ‘equity income’ funds whose aim is to produce a higher income yield than the average of UK shares and to make their dividends grow at above the rate of inflation.
The five are Artemis Income, Liontrust First Income, M & G Dividend, New Star Equity Income and Newton Higher Income. There are other excellent funds in the UK Equity Income sector but most of them don’t currently pay over 5%.
Their initial income yields, net of 20% income tax, are as follows:
| Artemis Income | 5.2% |
| Liontrust First Income | 5.8% |
| M & G Dividend | 5.6% |
| New Star Equity Income | 6.2% |
| Newton Higher Income | 5.8% |
The specific policies of the managers vary somewhat, but every single one of these funds has among its ten largest shareholdings either or both of BP and Shell and either GlaxoSmithKline or AstraZeneca; Vodafone; BT; and HSBC. Other household names in their top 10 lists are BG Group, Centrica, United Utilities, Lloyds TSB and National Grid.
On average, they hold 45% of their money in the very largest companies with a market value of over £10 billion and another 30% in companies valued at between £1 billion and £10 billion. These large companies are those least likely to cut their dividends, partly because their finances are far stronger than those of smaller firms.
The value of an investment in these funds will fall if the UK stock market takes another downward lurch. But if you only buy things when they have gone up a lot in price, you will never be a successful investor. It seems to me overwhelmingly likely that in five years’ time you will look back to find all these funds having delivered annual returns of 10% or more.
Five high-yield shares
The five shares I have chosen from the UK’s top 100 companies give you a spread across very different sectors of the economy: banking, telecoms, retail, utilities and energy. In each case I am using the City analysts’ forecasts of dividends for the current financial year. Like the five funds selected above, the idea is hold for at least 5 years provided that the firm continues to pay its dividends.
Five top stocks for top divis
| Stock | Revenue £m | Dividend yield |
| BP | 140,000 | 5.4% |
| BT | 20,700 | 9.2% |
| Lloyds TSB | 18,300 | 11.7% |
| M & S | 9,000 | 7.8% |
| National Grid | 11,400 | 5.0% |
Share prices and company information
At the moment, several of the banks are among those offering the highest yields, but I have gone for the safest, Lloyds TSB, because it has least exposure to the ‘credit crunch’ and because its board only a few weeks ago expressed confidence about increasing its dividend this year. The yield is 11.7%
When British Telecom announced plans to invest £1.5 billion in superfast broadband a few weeks ago, its share price plunged. Yet analysts can see that this strategy will enable it to crucify its competitors. In the meantime, landline telecoms are still a massive cash generator for BT. The yield is 8.8%.
Marks & Spencer is again suffering a hammering from City analysts who don’t really have a clue what’s going on on the High Street. Of course M&S will suffer in the current recession, and of all the five shares in my selections, I rate it the most vulnerable to a dividend cut. The yield is 7.8%.
National Grid is big and boring and does what it says on the tin - distributes our electricity. But the UK utilities regulatory system means its profits are and dividends are virtually guaranteed. The yield is 5.0%.
BP is one of the UK’s two oil giants. Believe it or not, despite the oil price having more than doubled since 2000, the share price today is lower than it was then. The forecast yield for 2008 is 5.4%.
Put an equal amount into these five shares and your total dividends in 2008-09 will represent a return of 7.8% on your capital.
If you want maximum security for your divis, leave out M & S and replace it with GlaxoSmithKline, one of the most successful big pharmaceutical firms with annual sales of over £22,000 million, where the yield is 4.4%. This will reduce the average for the five shares to 7.1%.
The opportunity to buy large, quality businesses paying divis bigger than you
get on deposit accounts doesn’t come along very often. Historically, it’s always been right to buy on these terms. But remember, this investment only makes sense on a 5-year view, so don’t even think about it if you’re likely to panic if prices suddenly fall by 10%.
Important risk warning - please read
The value of your investment and the income from it can go down as well as up and you may not get back a significant proportion of your investment. Past performance is not an indication of future performance. If you are in any doubt as to the suitability of an investment, you should seek independent financial advice.
