EQUITY INCOME (SHARES)
Over the long term, equities offer the potential for superior returns compared with many other major asset classes. An equity income strategy focuses on shares in companies that pay consistently high and rising dividends and typically aims to generate a consistent, above-average income stream, accompanied by the potential for capital growth over the long term.
Dividends are paid – usually in cash – by companies to investors and are taxable. By law, dividend payments must be paid out of the company’s profits or from profits generated in previous years. Companies are not obliged to pay a dividend, but a high dividend payout can provide an incentive for investors to take a stake in the company. A company does not have to pay a dividend, and many – particularly small- and medium -sized ones – prefer to reinvest surplus cash into the business.
The profits of a relatively young company, for example, will be unpredictable as it seeks to establish itself – and any profit it does make will probably be used either to repay start-up costs or as a reinvestment to help growth. Even as a company grows older, its management might decide to retain profits to finance debt, expansion or product development. Longer-established companies tend to pay higher dividends – hence an equity income strategy tends to focus on large, high-quality companies, rather than smaller, younger firms.
Nevertheless, a small but rising proportion of dividend payouts are coming from medium-sized and smaller companies. Even large, well-established companies can fall on hard times, however, and the management might decide to shore up their firm’s finances by reducing its dividend payout or cancelling it completely. Furthermore, a diminished or cancelled dividend will undermine confidence in the company and its share price is likely to be negatively affected, cutting the value of your capital investment.
While there is a long standing culture of dividend payments among UK companies, a growing number of companies in overseas markets are returning value to their shareholders in the form of dividend payouts. The US has, for example, traditionally been home to a core of large companies that pay high dividends. More recently, Asian companies have sought to attract and meet the needs of international investors by focusing on dividend payouts, with countries such as Hong Kong and Taiwan establishing solid dividend regimes.
A global equity income approach has become increasingly achievable, and many investment houses have launched funds to tap into this trend. UK-based equity income investors now have much greater scope to diversify across a broadening range of countries and to gain exposure to industry sectors that might be less well-represented in the UK stockmarket.
COLLECTIVE EQUITY INCOME FUNDS
An equity income fund invests in the shares of companies that pay consistent and attractive dividends and then combines the dividend payouts in order to pay a regular income to investors. Diversification across a broad range of companies reduces the danger a single company’s decision to cut or cancel its dividend might drag down the overall yield of the portfolio.
INVESTING IN EQUITIES FOR INCOME SUMMARY
In next months instalment of Investing for Income we will explore how property can be used to provide an alternative income to cash.