Dividends - the trillion dollar reason to stay invested in volatile times

Global investors received a record $1.25 trillion in company dividends last year

Since 2009, global dividends have risen by almost three-quarters. Illustration by Alex Belman for The National

Stock markets may be volatile right now but there are a trillion reasons why you should stay invested, and every one of them has a dollar sign attached.

Last year, global investors received a record $1.252 trillion in company dividends, a rise of 7.7 per cent on 2016, according to the latest Janus Henderson Global Dividend Index.

Payouts increased in every region and almost every industry, with the US, Japan, Australia, Switzerland, Hong Kong, Taiwan, South Korea and the Netherlands all posting record-breaking increases.

The star of the show was Asia Pacific (excluding Japan), where total dividends jumped 18.8 per cent to almost $140 billion.

Since 2009, global dividends have risen by almost three-quarters. Whether you hold individual company stocks, mutual funds, exchange traded funds (ETFs) or a pension plan, your portfolio will have felt the benefit.

2018 looks set to be even better year for dividends, with Janus Henderson forecasting underlying growth of 6.1 per cent due to the strengthening world economy and rising corporate confidence. It reckons that payouts will total $1.348tn this year, yet another record, and another signal to stay invested.

Last year’s dividend bonanza come on top of the $9tn of capital growth investors received from rising share prices, with the MSCI World index up 22 per cent.

This combination of share price growth and dividend income is what makes investing in stocks and shares so attractive.

The daily ups and downs of stock markets may generate more excitement but in the longer run, it is the dividends that will make you really wealthy.

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Dividend power

If you own shares in a company, you own a share of its profit. The company can choose to reinvest its profits back into the business or distribute it to shareholders in the form of a dividend, as a reward for holding its stock.

Major blue-chip companies tend to be the most generous dividend payers, for example, global bank HSBC yields 5.39 per cent a year while British oil major BP currently yields 6.34 per cent. By contrast, smaller, faster growing companies mostly prefer to reinvest profits back into the business to fuel further growth.

Mutual funds and ETFs also generate dividends from their underlying stock portfolios, which they distribute to investors.

You can either take these dividends as income, or reinvest them back into your portfolio for future growth.

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High interest

In this era of record low interest rates, dividends offer some much-needed respite.

Vijay Valecha, chief market analyst at Century Financial Brokers in Dubai, says the UK's FTSE 100 is particularly generous, currently yielding 4.02 per cent a year, while the Australia ASX 200 yields 4.28 per cent. “Even our local indices show great prospects, with the Dubai Financial Market on a trailing dividend of 5.53 per cent and the Abu Dhabi Securities Exchange at 5.33 per cent.”

The US typically offers lower yields than the UK, with the S&P 500 currently yielding 1.78 per cent.

Unlike the interest rate on a savings account, dividend payments are not guaranteed, but rise and fall with company performance.

BP was forced to scrap its dividend in 2010, following the Deepwater Horizon oil pipeline disaster in the Gulf of Mexico; its payout has only recently been restored. So you have to take the added risks into account.

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About the yield

When comparing how much income you get from different stocks or funds, the key figure to look for is the yield, which is the dividend per share expressed as a percentage of the company's share price

So if a company pays a $1 dividend and its share price stands at $20, the yield is a pretty generous 5 per cent a year.

Tom Anderson, senior investment manager at wealth advisers Killik & Co, says this figure must be treated with great care. "Yields change all the time as share prices move, and a high yield can conceal all sorts of problems.”

If the company issued a shock profit warning, and its share price collapsed to $10 as a result, the yield would leap to 10 per cent. This may look attractive but is unlikely to prove sustainable and may be slashed in future. Such high yields rarely last long.

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Dividends for growth

Mr Valecha says the key to getting rich from dividends is to automatically reinvest them straight back into your portfolio for future growth. “This way you pick up more stock units, and will benefit from the snowball effect as the income and growth compounds year after year.”

The process is further accelerated by the fact that most companies look to increase their dividends each year, he adds. “If you buy a stock that yields 4 per cent a year, and management increases the dividend by 3 per cent a year, you would double your money in less than 15 years, while after 30 years it would have risen seven-fold.”

Tuan Phan, a board member of Common Sense Personal Finance and Investing, a non-profit community of UAE investment enthusiasts, says dividends can also help to counteract the ups and downs of share prices. “Most companies continue to pay a dividend even if the market crashes, although maybe at a reduced rate.”

By holding tight and continuing to reinvest the dividends, you can actually turn stock market volatility to your advantage. “Your reinvested dividends will pick up more stock each month when share prices are low, which means you can reap a tremendous windfall when the market eventually recovers,” Mr Phan says.

Gordon Robertson, director at Investme Financial Services in Dubai, says reinvesting dividends makes a massive difference to your overall return. “Over the last 20 years the US S&P 500 has delivered a total return of 176 per cent. With dividends reinvested, that rises to 297 per cent.”

However, he adds that UAE residents must also beware of high investment charges that some advisers continue to impose, as this can really eat into the value of your income. “Fees totalling 4 per cent a year are common in the UAE. If your portfolio yields, say, 3 per cent a year, you could end up with a negative return after charges.”

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Dividends for income

Dividends do not just turbocharge your portfolio while you are investing for retirement, generating income after you finally stop working, beating traditional options such as an annuity, Mr Robertson adds.

Annuities offer the security of a guaranteed income for life but rates have plunged since the financial crisis, Mr Robertson says. “If you buy an annuity for $150,000 at age 65 you currently get level annuity income of around $8,500 a year, but inflation will steadily erode its real value over time."

You could buy an inflation-linked annuity where your income rises every year with prices, but this would reduce your starting income to just $5,200, a poor return on £150,000.

In contrast, Mr Robertson says investing $150,000 in a portfolio of dividend-paying stocks or funds could generate around £6,600 a year, and this should keep pace with inflation as companies increase their payouts.

Another attraction is that you retain access to your capital and its value will increase if stock markets rise, Mr Robertson adds. "The risk is that if stock markets go down, so does the value of your capital, which could ultimately reduce your dividend income.”

Fund tips

Experienced investors can build their own portfolio of dividend-paying global stocks, but Tom Anderson of Killik & Co says this is too risky for most.

He suggests spreading your risk through a mutual fund or ETF and tips Fidelity Global Dividend, which targets companies with predictable cash flows and sustainable dividends. It currently yields 2.93 per cent with a total return of 69 per cent over the last five years, according to Trustnet.com.

Mr Anderson also tips JP Morgan Global Growth and Income, which currently yield 3.55 per cent and has returned 97 per cent over five years.

Investors who prefer passive funds should consider SPDR Global Dividend Aristocrats ETF (GBDV), a low-cost ETF that targets global companies with stable dividend growth for at least a decade. It currently yields 3.56 per cent and is up 23 per cent over three years.

Oliver Smith, portfolio manager at IG Index, says ETFs are an attractive way to generate dividend income because their low charges mean you get to keep more of your money.

While active funds can charge as much as 1.5 per cent year, ETF charges begin from as little as 0.07 per cent.

You could access the FTSE 100’s 4.02 per cent yield through a ETF tracker such as iShares FTSE 100, Vanguard FTSE 100 or the HSBC FTSE 100 UCITS ETF, but Mr Smith also suggests another option for those who want even higher income: the BMO Enhanced Income UK Equity ETF (ZWUK).

This, he says, is a specialist fund benchmarked against the UK’s FTSE 100 that also sells "call options” on half the portfolio, which involves selling the right to purchase these stocks at a specific price within a set timeframe. This generates an extra 2 per cent of income, giving the fund an estimated yield of nearly 6 per cent.

Mr Smith warns that selling call options can limit capital growth. “This ETF could modestly outperform the FTSE 100 in a gently rising market and it has total expenses of just 0.30 per cent.”

The US stock market offers a lower yield than rivals such as the UK, but Mr Smith says SPDR S&P US Dividend Aristocrats ETF (USDV) could redress the balance, as it targets companies that have increased their dividend every year for the past 20 years. “These are mature businesses with progressive dividend policies that have shown a willingness to reward shareholders.” The ETF yields 1.85 per cent with charges of 0.35 per cent.

Finally, Mr Smith also tips Lyxor SG Global Quality Income ETF (SGQL), which invests in high-quality global stocks with market-beating dividends. “It looks both at the size of company dividends and avoids companies with highly leveraged balance sheets.”