The Lazy Investor's Guide To Growing Income

Investment trusts have a great record of growing dividends.

In an article a decade ago, Stephen Bland introduced his High Yield Portfolio (HYP) strategy on the Fool site, followed a week later by a demonstration portfolio. The strategy was designed as an alternative to an annuity, for those prepared to accept the risks of equity investment.

The idea was simple. Buy a diversified portfolio of high-yielding shares, selecting big companies, with a history of growing dividends and not too much debt, and … well, just hold on to them.

This strategy and variants of it have been followed by many Fools. All equity strategies struggled during the recent bear market, but for investors relying on a growing dividend income it was a particularly tough time. The aftershocks -- assuming the earthquake itself is over -- are still being felt and will be for some years to come. It's little consolation that interest on cash has fallen even more dramatically than dividends from shares.

Trust in investment trusts

One of the few sub-sectors of companies listed on the stock market to have come through the dividend turmoil with its payout record largely intact is the 'investment trust' sub-sector. The business of these companies is to invest in other companies.

In a recent article, Alan Oscroft made a strong case for 'Why investment trusts are Foolish'. In conclusion, he noted that they can make extra profits in good times by borrowing money to invest and that despite the potential risks of gearing, over the long-term investment trusts regularly outperform other types of fund, such as unit trusts.

What about income?

One of the characteristics of investment trusts that Alan didn't mention in his article, is that they are not obliged to distribute all their annual net income to shareholders. Many investment trusts operate a prudent policy of running a 'revenue reserve', which they add to in times of abundance and drawn on in times of famine.

This policy has stood trusts in good stead, enabling them to continue to pay out a growing dividend to their shareholders through thick and thin, including in many cases through the recent dividend nightmare. It's a policy that many Fools following a HYP strategy also use – basically, a 'safety margin'.

So, can investment trusts do a job for income seekers who are even more indolent than the average HYP investor?

I reckon they can. Here's a portfolio of investment trusts:

^{* denotes a 20+ year record of increasing dividends.}

Diversification

I've selected a portfolio of 10 investment trusts in order to reduce risk. A freak 'black swan' event that completely wiped out one trust wouldn't be the end of the world for the income stream. There are other trusts that might be worth considering in addition to those I've selected: for example, Edinburgh Investment Trust (LSE: EDIN), the management of which has recently been taken over by Invesco's Neil Woodford.

Diversification by geography I don't see as a big risk issue: eight of the trusts are UK-focused, but the giant international companies of the Footsie are well-represented. I've also included a couple of trusts with a global mandate just for variety.

Diversification by industry sector of the trusts' underlying holdings is a bit more balanced overall than that of the FTSE All-Share, which I see as a good thing.

High yield and income growth

The portfolio has an average starting yield of 4.6% versus the FTSE All-Share's 3.2% -- that's over 40% more income at the outset.

All the trusts have a history of increasing their dividend payout every year for at least the last 10 years. As noted earlier, the six marked with an asterisk have records of over 20 years' dividend growth, City of London being the head of the elite with a 43-year record.

Furthermore, all of the trusts have the objective of increasing dividends in the future, mostly couched in terms of 'real' growth or 'in excess of the rate of inflation.' Bankers Investment Trust, the lowest yielder in the portfolio has already committed to an increased dividend next year, and, though it's in the 'Global Growth' sector, has an explicit income policy of 'regular dividend growth, in excess of the increase of the Retail Prices Index.'

The safety net

Finally, all 10 trusts have substantial revenue reserves, as can be seen in the last column of the first table headed 'Dividend cover by revenue reserve'. A figure of 100% means that the reserve is equal to the previous year's entire dividend payout. Obviously, the higher the percentage, the greater the cover.

Even with reduced income from the underlying companies that the trusts are invested in, with these levels of reserves to make up any shortfall, they could go on increasing their own dividends for several years if necessary -- although it appears that we are now past the worst of the dividend mayhem in the wider market.

Are investment trusts the simplest way to get a growing income from equities? It's a strategy I think I'll be looking at again should the day arrive when I no longer have the capacity or inclination for a more active style of investment.

More from G A Chester:

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• The 'Lost Decade' For Shares

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