With interest rates being stuck at 0.5% for what has felt like an eternity, anyone with cash has endured a painful period. While interest rates may move up following Brexit, there’s also a chance that they’ll move down and hurt the returns on cash to an even greater extent.
Furthermore, inflation could increase due to a weaker currency causing imports to rise in price. Combined with a recession and an enforced low interest rate, this could make the real returns on cash (i.e. when inflation is taken into account) even less appealing.
Although there’s no perfect solution for this, higher-yielding shares seem to be the best answer on offer. That’s because it’s quite straightforward to generate a net yield (for basic rate income tax payers) of over 4% right now. In fact, a number of major FTSE 100 companies are yielding 5% or even over 6% following the recent turbulence in the UK stock market.
Defensive characteristics
Clearly, such a return dwarfs even the best fixed rate bonds on offer through high street banks. And despite shares being riskier than cash in terms of them being closely tied to the performance of the company they’re small pieces of, many higher yielding stocks offer excellent defensive prospects.
For example, tobacco and healthcare stocks have risen in the main following Brexit. That’s because during turbulent times they’re often viewed as being perceived defensive assets and investors flock to them in search of safety. This makes sense because such companies aren’t as closely linked to the performance of the economy as is the case for many of their index peers.
Furthermore, a number of shares offer very stable dividend outlooks. As well as profit forecasts being upbeat and relatively strong, many companies have an excellent track record of delivering profit growth in previous years. And they’ve often increased dividends year-in, year-out over a prolonged period. While this doesn’t guarantee future dividend growth, it does mean they may continue to do so due to a lack of need for reinvestment and acquisition activity.
Payout ratio
Undoubtedly, a key focus for income investors should be a company’s payout ratio. This measures the proportion of profit being paid out as a dividend each year. A lower percentage figure indicates greater headroom from which to make dividend payments during more challenging periods for the business when profitability may come under pressure.
As mentioned, inflation could prove to be a major threat to investors holding large sums of cash. With many companies having the potential to move their pricing in line with inflation, their profitability and dividends may be able to at least keep pace with rising prices over the medium-to-long term.
There are no guarantees that investing in a company will yield a high total return and it could lead to losses. But diversifying among a number of higher-yielding stocks with sound track records of dividend growth, a modest payout ratio and operating in resilient sectors could be a means of beating the terrible savings rates currently on offer.
