Today, savers are playing a game they can’t win. With the average easy access savings account now paying just 0.5%, according to Moneyfacts.co.uk, they’re onto a surefire loser. Inflation is low but not that low at 0.6%, which means that millions are seeing the value of their cash eroded in real terms.
Wicked game
Bonds aren’t much better, with UK 10-year gilts yielding just 0.56%. The UK property market looks vulnerable to Brexit fallout, while former Chancellor George Osborne’s parting tax shots at buy-to-let investors have wiped out many of its attractions.
Where cash, bonds and property are concerned, the game looks increasingly rigged. Dividend-paying stocks, by contrast, are a far more attractive bet. The odds are pretty good for a start, with the FTSE 100 currently yielding 3.71%, which is almost 15 times base rate and seven-and-a-half times the average savings account.
Check these top yields
You can get an even higher yield by targeting individual companies, with big names such as BP, HSBC Holdings, Legal & General Group and Royal Dutch Shell all yielding more than 6%. Obviously, this is riskier than leaving your money in the bank, with oil company yields particularly vulnerable as profits are squeezed. Which is why it’s best to spread your risk between a number of companies, either by building your own portfolio of stocks or if that’s too complicated through a low-cost FTSE tracker.
One of the big attractions of company dividends is that most businesses aim to increase them over time, as the business grows and cash flows increase. This means that with luck, you’re locking into a rising income stream, so today’s yields will look even more impressive in future years.
Say you buy a company that costs £1 per share today and pays a dividend of 5p. The yield is 5%. Let’s say that next year the dividend is hiked to 6p and then 7p the following year. Effectively you will be getting a yield of 7% on your original money, plus any share price growth on top. By reinvesting those dividends you pick up more stock and get more dividends, accelerating the compounding effect.
Brexit bonus
It’s important to remember that company dividends are never guaranteed, and are vulnerable to a cut if profits flounder. UK dividends are coming under pressure today, falling 3.3% year-on-year in the second quarter, according to the latest Henderson Global Dividend Index. Standard Chartered, Anglo American, Barclays and WM Morrison were among those making steep cuts.
Yet I’m not worried, because dividends still offer a far better return than you can get elsewhere, and will almost certainly continue to do so. Q2 dividends total $33.7bn, up 7.7% over the year, thanks to large special dividends from GlaxoSmithKline, Intercontinental Hotels and others. Better still, UK dividend investors have benefitted from Brexit. Many top UK companies pay their dividends in dollars and in some cases euros, and these are now worth more when converted back into sterling.
Generous yields, compounding benefits and the potential for rising yields make dividend investing about the most enjoyable game that any investor can play right now.
