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Why equity income investing is a good way to grow your money
Investing in stable, well-run businesses that pay healthy dividends can be a good way to turn your savings into income.
by Gavin Lumsden on Sep 28, 2012 at 16:30
Equity income investment is a classic way of making money from the stock market. It's all about buying shares in well-managed companies that pay good dividends to their shareholders.
If you are a DIY investor you can build a portfolio of income stocks on your own, or alternatively you can invest in one of the many equity income funds available.
In this video Gavin explains how dividends can help turn your savings into an income stream.
Hello and welcome to the Lolly Investor Programme.
Well the summer is definitely over!
As I thought about this week’s topic all the wet weather we’ve had reminded me of the nursery rhyme about Incy Wincy spider.
Incy Wincy shows great resilience as she climbs up the spout again and again after each shower of rain.
Just like investors! In the past 12 years investors have been washed away by a series of downpours culminating in the biggest soaking of them all in the 2008 financial crisis, from which we are still recovering.
After each shower comes the sun, however.
And drying up some of the rain for investors in recent years has been the re-emergence of a classic way of investing in the stock market.
It’s called equity income and it’s what I want to talk about today.
Equity income investing is about buying shares in well-managed companies that pay good dividends to their shareholders.
Good doesn’t necessarily mean big. It means dividends that are sustainable and that grow above inflation.
If you are a DIY investor you can build a portfolio of income stocks on your own.
Alternatively you can invest in one of the many equity income funds available, which will do the job for you.
The great news for investors is that companies in the UK generally have a good attitude towards paying dividends to their shareholders.
And the dividend culture is spreading. The US, not surprisingly, is also pretty good at looking after shareholders, while Europe and Asia are getting better.
This means there is a growing number of global equity income unit trusts and investment trusts to choose from, as well as the UK equity income funds investors have traditionally used.
Dividends are a crucial part of the total return investors can get from the stock market if they reinvest them.
£100 invested in the UK stock market after the second world war would be worth around £7,400 today if you had taken the dividends and spent them.
But if you had reinvested those dividends back into the stock market that £100 could have been turned into over £130,000.
Here’s another statistic.
The UK stock market has generated an average annual return of nearly 5% over inflation since 1970.
Most of that, around 4%, has come from the initial dividend yield investors would have got when they invested 42 years ago.
Let’s remind ourselves about dividend yields.
The dividend yield is a percentage that measures how much dividend you get for each share you own.
Dividend yields move in the opposite direction to share prices. So if a company’s share price falls and gets cheaper and if it maintains the level of its dividend then the yield will rise.
The higher yield means you’re buying more dividends when share prices are low.
In other words we’re back to the fundamental rule of investment that you should buy when prices are low and sell when prices are high.
This leads me to a second piece of good news for investors.
The UK stock market is relatively good value at the moment.
One measure of this is that the FTSE All Share index currently yields 3.6%. Meanwhile the yield on UK government bonds, traditionally an important source of reliable investment income, is only around 1.3%.
In other words government bonds are expensive, shares are quite cheap.
Moreover, many big companies are cash rich and should be able to continue growing their dividends above the rate of inflation, unless we fall back into a really serious recession.
To sum up now is a really good time to get into equity income investing.
If you are a younger person wanting to grow your money over the long term the equity income approach is a tried and tested means of generating a good total return.
If you’re older and want to take the income, equity income funds are a good solution, although there is always the risk that a big stock market crash will make a big dent in your capital.
Like Incy Wincy there is always the chance that markets will send you tumbling again.
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