The value of investments and any income from them can fall and you may get back less than you invested.

The danger of chasing dividend yields

Share

Performance of the top 10 highest dividend-yielding shares vs the FTSE 100 over five years

Investors have been paying a lot of attention to dividends in recent years. Since the financial crisis of 2008, interest rates have been near record lows making it difficult to generate income by putting money into bonds or savings accounts. Many investors have turned to company dividends for their income needs.

While this will often have been a sensible strategy, the popularity of dividends has created some misconceptions. Chief among these is that a high yield is always a good thing.

The return investors receive from most businesses is made up of two parts: dividend income and capital (otherwise known as share price) growth. By focusing too heavily on dividends, there is the risk that investors ignore the other side of the equation, the prospects for capital growth.

The graph above demonstrates what would have happened if you had invested in the 10 highest-yielding shares in the FTSE 100 five years ago. Because these high-yield companies have suffered share price falls, even when dividends are factored in, you would have done better with the benchmark FTSE 100 index. The same is true over 10 and 15 years  [1].

Alistair Douglas, investment manager at Brewin Dolphin, says: “The UK stock market has traditionally offered an attractive level of income, but investors need to be wary of purely chasing high-yielding shares. While the temptation might be to try and maximise income from a portfolio, these figures show that it may not be as profitable as investors might believe.”

More important than a high yield is that the dividends being paid are sustainable. Sometimes a high yield is a sign that a company is in distress and its dividend will be cut.

“Investing is a long-term game and finding strong businesses which have a lower starting yield, but are growing the dividend sustainably year on year, will likely prove to be a more profitable investment,” says Douglas.

Diversification is another important facet to consider as the highest yielders may be concentrated in a small number of stock market sectors. A lack of diversification will make your investment portfolio higher risk.

You may hear some people argue that following a simple investment strategy, such as investing in the highest yielding shares, will pay dividends. Over short periods that might be the case, but the evidence suggests that investing for the longer term requires more work.

At Brewin Dolphin our investment experts can help you put together an income portfolio that reflects both your risk appetite and long-term income needs.

 

 

[1] Source: Brewin Dolphin. Figures calculated from 1 June 2004, 1 June 2009 and 1 June 2014 to 31 May 2019.  Returns include dividends paid and capital gains from share price movements which together make up the shareholder return.

Past performance is not a guide to future performance.

The value of investments and any income from them can fall and you may get back less than you invested.

No investment is suitable in all cases and if you have any doubts as to an investment's suitability then you should contact us.

The information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.

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