Income shares are one of three actionable ways investors can use the stock market to build a retirement pot. Picking and holding the stocks of businesses paying dividends can be a steady strategy for building wealth.
A powerful indicator of value
The UK’s first publicly declared ISA millionaire, Lord John Lee, is a big fan of dividends. And his book How to Make a Million – Slowly is a worthwhile read that can help guide investors.
Lee wrote that the payment of a dividend is “very important”. The practice indicates a company is making a profit and has enough to commit to shareholders. And there’s an obvious benefit to the private investor in receiving the cash.
He said he’s always been a lover of dividends. By reinvesting and compounding them, dividends contributed much to the growth of his ISA over the years.
In the recent bear market conditions, Lee doubled down on his focus on dividend-led investments. He‘s been buying shares in companies such as Legal & General, Aviva, STV, MP Evans, Anpario and others.
He likes his investee businesses to at least maintain dividend rates in a difficult period. That’s because reducing or passing dividends can “leave a scar on a company’s record which can never be erased”.
Focusing on dividends first can be a great strategy. A firm’s dividend record and the directors’ decisions about the shareholder payment can reveal much about the health of a business.
In his book, Lee wrote: “The payment of a dividend acts as a significant discipline on the board of a PLC in that it has to find the cash each year to pay those dividends”.
Always dividends first
His first guiding principle is to look for modest valuations and an attractive dividend yield. And that applies even when seeking total returns and not just income.
A focus on total returns is the second actionable way investors can use the stock market to build a portfolio of stocks capable of paying income for retirement
That means targeting capital gains from a rising share price and increasing income from an increasing dividend.
Lee makes the presence of a dividend a big part of his strategy for finding growing businesses with the potential to deliver decent total returns.
The London stock market has produced some impressive total-return success stories in recent years, such as Diploma, Bunzl and Halma. Those stocks could have contributed to building an early retirement pot for investors.
However, positive outcomes from picking the shares of individual companies are never certain or guaranteed. All businesses can sometimes face challenges. And it’s possible to lose money on stocks held long term, even when focusing on dividends first.
That’s where the third actionable way comes in for investors to use the stock market to build a pot targeting an earlier retirement.
This way aims to reduce some of the workload by investing in passive tracker funds, managed funds and investment trusts. Again, focusing on dividends first can be a good starting point for research.
My own way involves allocating parts of my portfolio to all three ways of approaching the stock market. And I’m aiming to generate a pot large enough to provide income for an earlier retirement.
