The case for and against dividend investing
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
When markets are dropping and capital growth falters, many investors are drawn to dividend funds to provide a regular income stream. In 2022, we have seen this behaviour in action as indexes like the S&P 500, Dow Jones Industrial Average (DJIA) and others fall whilst more investors flock to funds that focus on paying dividends.
Yet will the outperformance of these funds be maintained, and are they appropriate as a core feature of your portfolio? In this article, our financial advisers at Castlegate here in Grantham, Lincolnshire offer some answers. We hope you find this content helpful. If you want to discuss your own financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
The appeal of dividend-paying funds in 2022
Two factors are high in the minds of many investors in 2022. Firstly, western stock markets have struggled to generate meaningful returns. The S&P 500 has declined by 18% since January, for instance, and the DJIA has fallen by 17%. Secondly, inflation is also running high – standing now at 9% here in the UK (the highest rate in 40 years). This makes cash less of a “safe haven” for nervous investors than when inflation stood closer to 2%, since regular savings accounts cannot hope to beat inflation with their interest rates.
Given this broad landscape, many investors have been drawn to funds which focus on investing in dividend-paying stocks. There are at least two reasons. Firstly, many “dividend stocks” have a track record of lower price volatility compared to “growth” stocks which feature heavily in public stock markets (e.g. Apple, Amazon and Facebook). This provides a sense of comfort and safety from further price falls. Secondly, dividends are psychologically rewarding in that they provide a regular “passive” income (e.g. once per quarter).
Drawbacks to consider
Naturally, since all investors face the same tough overall investment landscape, most have had the same idea to consider dividend-focused funds. This has driven up the share prices of many of the stocks contained inside them, making them more “expensive” to invest in. Unfortunately, here we see the risks of trying to “time the market”. If you think that you have found a “magic bullet” for your portfolio during tough conditions, almost certainly other investors have already thought of it and acted – pricing it into the funds you are looking at.
Another risk to think about is that dividends are not guaranteed. During a recession, a company may decide to lower or suspend its dividend for a season, even indefinitely, to plough more profit into protecting the business. Given that, according to the CBI and other professional bodies, the UK might enter recession in 2022 or next year, investors should take care not to pile capital into dividend funds without first consulting a financial adviser.
Finally, bear in mind that dividend-paying funds may have lower growth potential compared to those which focus on growth. This is because companies that distribute profits to shareholders have less to invest back into their business to help it grow (increasing the share price along the way). So, whilst dividend funds might be appealing in the short term as investors face uncertain market conditions, they may not suit your long-term growth strategy.
How should dividends feature in my portfolio in 2022?
As always, the answer to this lies in multiple factors which depend on your personal financial goals and situation. For instance, suppose you are looking to retire soon and want to “de-risk” your portfolio (i.e. move away from riskier investments which could lead your portfolio to fall in value sharply just before you retire). Here, it may be appropriate to include more funds which focus on providing dividends. After all, investment growth is less important to you now and the priority is likely to ensure a steady income stream in retirement, with minimum portfolio volatility.
However, a younger person with a long investment horizon before them (e.g. 30+ years) is likely to get more value from focusing more of their portfolio on “growth” funds. These may pay little to no dividend along the way, but could have more long-term potential to grow and provide a large retirement fund as you later wind down your career. Minimising portfolio volatility is likely to be less of a priority (unless your risk appetite is lower), as you have many years to recover and surpass stock market falls along your investment journey.
Regardless of whether dividends feature in your portfolio or not, it is crucial to ensure that you maintain an appropriate level of diversification. Piling too much money into a single stock which pays an “above market average” dividend, for instance, is likely a bad idea. If that company stops its dividend, for instance, then your portfolio could be disproportionately harmed. Consider seeking financial advice if you have questions about how to best construct your portfolio.
Conclusion & invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585