The UK Has Seen the Biggest Quarterly Fall in Dividends on Record, Here’s Why Accomplished Investors Shouldn’t Worry
30/10/2020
In the headlines, the news looks bad, but this is precisely the eventuality that a sensible investor should be prepared for. At BpH Wealth we follow the evidence, which suggests that relying on dividends in your portfolio has never been a good strategy, this is just the most recent example of why. In times of market turmoil, it is more important than ever to maintain good investor discipline and trust that a well-constructed portfolio will ride out the worst of the tough times ahead.
The latest quarterly UK Dividend Monitor from Link Asset Services, the largest share registrar in the UK, has shown the biggest quarterly fall in UK Dividends in the second quarter of 2020 as Covid-19 forced companies to buttress their balance sheets. Total dividends paid in the second quarter of 2020 in the UK were 57.2% less than for the corresponding period in 2019. In hard cash terms, investors received a reduction of £22bn in their Q2 income.
For comparison, during the global financial crisis, UK dividends fell by 0.1% in 2008 and 10.9% in 2009. They did not return to above their 2007 level until 2015 once inflation is allowed for. Link Asset Services note that 2021 may see a rebound, but it will likely be several years before dividends reach 2019 highs.
Dividends fell sharply – and are expected to remain low
Source: Link Asset Services UK Dividend Monitor – Issue 42 – Q2 2020
There is no doubt that Covid-19 will have a lasting impact on economies and business, not to mention the personal toll and tragic loss of life. However, we are resilient and so too are businesses and financial markets. Dividend cuts are one tool available to businesses to help ensure their ongoing success and to help fight the financial impact of the virus. Of course, some businesses will suffer more than others and, as is ever the case, there will be winners and losers.
Why Accomplished Investors Need Not Worry
Despite all of this, provided you have maintained good investor discipline up to this point, no action should be needed in reaction to recent events.
When looking to ensure that our client’s portfolio is resilient to all market conditions, BpH Wealth look to techniques with a proven track record of working throughout history, these steps include:
Diversify
Having all your eggs in one basket can put you at a lot of risk, especially when shocks hit the market. Diversifying investments as broadly as possible means your portfolio’s performance will depend on global markets rather than individual companies. It is the first step in mitigating the risk of individual company failures – and the failures of individual regions, sectors and asset classes too.
Research shows that markets price assets efficiently and that active managers trying to outguess the market are more likely to underperform the market than outperform it – and those that outperform do not do so consistently. Therefore, by owning the market rather than trying to select individual stocks and shares, investors improve their chances of success over the longer-term.
Research also shows that the more an investor diversifies, the more the risk adjusted returns improve. Put simply: investors should achieve a higher return for each ‘unit’ of risk they take. Investors should be properly rewarded for the risk they take.
John D Rockefeller may have greatly enjoyed receiving his dividends but planning your investment strategy around them is misguided. Our comprehensive research shows that since 1924, when Rockefeller himself was still alive, income investing has been a suboptimal approach for investors to take. This involves picking stocks or bonds that offer a higher income that matches the investor’s needs. Often, investors feel comfortable with the perception of preserving capital and drawing only the natural income – saving the goose that lays the golden eggs.
The evidence suggests this approach is flawed and the recent fall in dividends demonstrates precisely why:
- It gives rise to a variable, unstable income.
- It reduces portfolio diversification.
- It promotes holding higher-risk investments.
- It is generally more expensive and less tax-efficient.
So, what should an investor do?
BpH Wealth believes in investing on a total return basis – meaning a stable and sustainable withdrawal that can then be taken from a combination of income (interest and dividends) and capital gains which in many cases is released within the annual capital gains tax allowance during the rebalancing process each year.
Paying dividends is just one way that businesses can deploy their capital and it involves a significant trade-off– reinvesting profits within the business for growth, and business growth leads to the value of investments increasing.
Total Return & Income Investing
| Total Return | Income Investing |
|---|---|
| Reliable and flexible income. | Unstable and inflexible income. |
| Broad diversification remains not only possible but is a cornerstone of sound investment. | Seeking higher income investments reduces diversification and increases both portfolio and stock-specific risks. At the final quarter of 2019, just 15 companies accounted for 64% of UK dividend payments by value. |
| Generally lower-cost strategies that improve the overall return to investors. | Generally higher-cost strategies that erode the overall return to investors. |
| Capital Gains Tax rates are lower than Income Tax rates – investors should get a higher net return, all things being equal. | Income Tax rates are higher than Capital Gains Tax rates – investors should get a lower net return, all things being equal. |
Any withdrawal or income strategy must be sustainable – and any withdrawal rate in excess of 3% per year should be analysed more deeply. A higher withdrawal rate might be sustainable but understanding the chances of a positive outcome should help to avoid any nasty surprises in the future. Applying a few simple rules, if necessary, can also help improve the chances of a favourable outcome. These rules might include limiting increases where investments fall, taking a pay rise when investments perform well, or a pay cut if they fall by 20%.
Cash Is King
Where possible, Investors should avoid finding themselves in a position where they need to sell investments in adverse market conditions. To do so risks selling investments at a loss or at sub-optimal values and eroding the value of your remaining investments. Therefore, we recommend an income reserve should be held so that can be drawn down instead of investments, allowing withdrawals to be modified or suspended. This should help hasten the recovery of your portfolio which in turn should help ensure the longer-term sustainability of withdrawals.
Sit Tight
Whilst there may be hard times ahead, the impact we are seeing is not unprecedented and a recovery in markets will follow – it is just a question of when and how smooth the ride is in the meantime. It is in these extreme times that it is most important good investor discipline is maintained.
Selling investments out of fear is likely to crystallise losses and erode investments. Therefore, by taking the right steps, an accomplished investor can sit tight, focus on the longer-term and maintain faith in the resilience of markets.
In Summary
Through good times and bad, our message remains consistent:
- Maintain good investor discipline – markets will recover.
- Diversify broadly – this is the only ‘free lunch’ when investing.
- Aim for a total return – don’t take more risk by chasing income.
- Minimise tax – improve net returns using allowances and paying lower rates of tax where possible.
- Adopt a sustainable withdrawal rate – an investor’s income does not need to be dictated by companies’ dividend policies.
- Maintain adequate cash reserves – in extreme conditions these can be withdrawn to allow time for a portfolio to recover.
For more information, see our BpH Insights:
We recommend you talk to an adviser if you wish to discuss this further.
Risk Warnings
This article is distributed for educational purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily the Firm and does not represent a recommendation of any particular security, strategy, or investment product. Information contained herein has been obtained from sources believed to be reliable but is not guaranteed.
Quoted values and opinions of Link Asset Services do not necessarily reflect the views and opinions of BpH Wealth Management LLP.
Past performance is not indicative of future results and no representation is made that the stated results will be replicated.
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