Equity Pays Dividends

An investment portfolio of dividend-paying UK equities can provide a steady income.

Many people think that you make money from shares by selling them when the price goes up. In fact, income from equities in the form of dividends can provide the lion's share of total returns from an investment portfolio over time. Since 1950, UK equities have returned 6.1% per annum, of which almost 4.5% has come from dividends (Source: Barclays 2012 Equity Gilt Study).

The yield on the UK equity market, as measured by the FTSE All-Share Index, appears very attractive compared to almost all other asset classes. The current yield of 4% for the overall market compares to UK 10-year bonds yielding just over 2% (Source: FT UK Benchmark 10-year Government Bonds, April 2012), with bank deposit rates equally low. Looking at the largest ten stocks in the FTSE 100 – often known as blue-chip companies – the attractions of some equities from a yield perspective seem even more compelling. For example, the largest stock in the UK equity market Royal Dutch Shell yields 5.2%, as does GlaxoSmithKline, while HSBC yields 5% and BP just under 5%.

Beat inflation

An investor can build a portfolio – either by buying individual shares or investing in a unitised vehicle – and expect to achieve a current running yield in excess of many other asset classes, such as cash and bonds. Equities also have an advantage over conventional bonds in that they provide a hedge against inflation. History shows that over time, dividends more than match inflation, with all of the above-named stocks expected to grow their dividends by over the forecast rate of inflation.

Of course, equities are high risk and more volatile than cash or bonds, but a diversified portfolio of the largest stocks in the equity market reduces this risk. Because of their yield and the type of industries they tend to operate in, income shares may be less volatile than the wider equity market.

Spread the risk

The UK-listed companies that pay respectable yields also tend to be geographically well diversified. This reduces the risk to the investor of a recession in one particular market and often gives exposure to fast-growing emerging markets. Companies are reticent to cut dividends because of the negative signals it sends to investors about their long-term prospects, and for the wider overall equity market, there are few years when dividends are cut in nominal terms (Source: Barclays 2012 Equity Gilt Study).

In conclusion, a portfolio of high-yielding, blue-chip, UK equities can offer investors a current running yield higher than most asset classes, a growing income stream over time and one with a degree of protection against inflation. Generally, these companies should provide a lower risk to capital than the overall equity market, with some exposure to the fastest-growing regions and countries around the world.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.