Searching for financial mines with your foot
WE covered taking income from investments last week and the risk of taking ‘income' from just one source.
For example, some believe that ‘income' means dividends from stocks/shares, or fixed interest returns from bonds etc, whilst others believe that a pot of money that grows and allows you to take withdrawals as and when you need to is better.
I'm with the latter.
As we discussed last week, the latter option gives the flexibility to move between whatever investments are producing the better returns, whether it be growth or value.
We should also not forget the geographical restrictions and sectoral restrictions that investing by a ‘where is the best dividend' strategy brings.
Geographical: Some countries aren't known for paying out dividends as a strategy, so by choosing based on a dividend yield alone, you would have missed out on most of the US growth. US companies prefer share buybacks, and so dividend pay outs are lower.
Let's remember their economy and its companies represent a large proportion of global growth.
The UK is known for its historic higher yields, but with the current Brexit stalemate, UK domestic stock's share prices have been under severe pressure as have their earnings.
Income at the cost of capital growth.
Sectoral: By focussing just on your dividends, some sectors like technology can easily be ignored, as they are not necessarily famous for income production, but that will damage your overall returns significantly due to the loss of their growth.
Because sectors such as utilities, commodities and financial stocks tend to have the higher dividends, you can find your capital exposed here as they can be very cyclical i.e. produce returns during a period then benign for a long period.
Such a scenario means that dividend seeking investors can move into a crowded place where stocks can easily become overvalued. That's fine, as long as you are out before they become undervalued.
Still on the sectoral argument, an income and growth fund can easily move between growth and income stocks and also take advantage of those technology stocks with strong balance sheets and robust growth plans. Ignoring Cisco (a technology company) would have meant missing out on its growing dividend which increased by 16 per cent per year from 2011.
Dividends are vital for sure. $100 invested in 1940 in the S&P500 would have returned $174,000 in 2011, whereas, if you had taken the dividends out each year it would have been worth just $12,000 so you can see the power of the dividend.
I remember a telephone call in response to the column, where an investor asked me to assess a stock offering 67 per cent yield (income). His comment was that in 18 months, he would have received his money back. “As long as it survives eighteen months” was my reply.
It didn't, nor would have his investment.
The higher yielding stocks tend to be the more distressed stocks. Take Plus500 as an example. Offering the highest yield of the FTSE350, at a staggering 28.98 per cent, investors could gallop unerringly into a stock that has indeed had a 66.39 per cent fall in share price over the last three months alone.
On a recent broker note, only four even commented on whether or not to buy it. Five is normally the starting point where you could remotely have a consensus.
Saga is number two on the list of yields, at a very attractive and luring 15.2 per cent, but its share price has fallen over 50 per cent in the last six months.
To give you a bit of perspective, over the last year, £100,000 invested between the two highest yielding stocks in the FTSE350 today would have yielded £22,090, whilst your capital would have fallen by £60,940.
You would have had a yield rich year, but would be starting the next year with just £39,060.
Your finances would never recover.
Naturally you wouldn't spread your investments so thin but you get the point that using yield as a determining factor is like searching for mines with your foot.
Best of luck with that.
:: Peter McGahan is chief executive of independent financial adviser Worldwide Financial Planning, which is authorised and regulated by the Financial Conduct Authority. If you have a question on investments please call Darren McKeever on 028 6863 2692, email email@example.com or visit www.wwfp.net.