HAVE A MIGHTY TUESDAY

HOW TO INCREASE YOUR DIVIDEND INCOME ?

In a low interest rate environment, bank accounts are paying very little in interest. Government bonds, too, offer interest yields well below the rate of inflation, so your money not only won’t pay you a decent income, but will gradually lose its purchasing power. If you live on the interest from your savings, you could be facing lean times.

Instead, you could look to equities to contribute a growing proportion of your income. There’s obviously a risk to investing in companies, since their profits could decline or they could even go bankrupt. But there’s also a reward, in terms of a higher current income than you can get from fixed-interest investments, plus the expectation that over time, your dividend income will increase as the companies in which you have invested grow.

Look for companies paying a dividend above the market average and you can achieve from 3.5 to 6 percent yields across your portfolio. That’s considerably more than you would get from a deposit account or from government bonds, and rewards the risk that you’re taking by investing in shares. However, you’ll need to be smart to avoid some of the obvious pitfalls and avoid investing in shares that cut their dividends or see their share prices fall precipitously.

First of all, avoid stocks with a yield very much higher than the market. If a stock’s dividend yield seems too good to be true, it probably is. Often, stocks appear to trade on 8 or 9 percent yields because the market expects them to cut the dividend or even stop paying one at all. Unless you are an expert investor and willing to spend time going through the annual reports and making your own judgment on the company, it’s probably best to avoid the highest yielders completely.

Secondly, look at dividend cover – that is, how much post-tax income is available to pay the dividend. That’s expressed as a ratio; if the cover is close to one, that means the company is paying out almost all its income as dividend, so if income falls, the dividend could be cut. If, on the other hand, the cover is two or three times, the company has enough reserves to keep paying its dividend even if profits decline temporarily.

Thirdly, look at the company’s debt position. If a company has substantial debts, it may not be able to pay a high dividend, because interest on the debt has to be paid first. Companies which are not so highly leveraged, or which have good cash reserves, are preferable.

You also need to consider the underlying business in which you’re investing; you can’t invest purely on the basis of the financial statistics. Some stocks pay high dividends because they are in declining industries, or in heavily regulated sectors like energy. Pharmaceutical stocks often pay good dividends, but you have to consider the ‘patent cliff’ – the fact that some of their patents will shortly expire, so earnings could dip. Other companies pay high yields simply because they operate in an unpopular sector or are not well known to investors. Always consider what analysts are saying about future growth.

The best thing about income investing in equities is that if you buy stocks which are still growing strongly, the yield on your initial investment will grow year by year. Now that equities are yielding several times what bonds can deliver, the market is delivering you a bargain. Bonds will pay you the same yield in ten year’s time that they do now, while a good equity investment yielding 4 percent today might be paying 6 to 8 percent on your initial price in five years’ time.

There are risks to be considered, of course. A company could become insolvent, or could see its profits or share price fall. However, you can reduce the risk by diversifying your investments. For instance, you might invest in a bundle of ten or twenty different stocks. Assuming that you spread them across the market so that you are not over-exposed to a single sector, you will have greatly reduced the impact that any one corporate failure or dividend cut could have on your portfolio’s income returns or your capital.

You might also consider investing in funds to diversify further. For instance, funds such as Newton Asian Income enable you to access income investments in overseas markets, so you are not wholly exposed to the fortunes of the domestic stock market. Asian markets are also likely to grow faster than the developed markets of Europe and the US, so you are gaining exposure to higher dividend and capital growth.

By investing in high yielding equities, you will not only be increasing your current income well above what most bank accounts or bonds can offer. You will also be creating a portfolio that can deliver steady, increasing income in future – and that is something that neither bonds nor cash accounts can give.