I missed out on a big investing win by focusing too much on growth

Times

12 hours ago

When researching a topic, every so often I will stumble across something that will stop me in my tracks. It could be some golden nugget of information that I had never heard before, or perhaps a calculation that spits out a number I wasn't expecting.
Last week, I had one of these moments when looking at the returns on investment trusts.
Initially, I had focused on share-price returns alone. The Brunner Investment Trust, a global equity fund, had returned about 150 per cent over ten years, for example. The 3i Group trust, which invests in private equity, has returned a whopping 645 per cent.
But then I looked at these trusts' total returns (the returns including dividends). The difference was staggering: the Brunner Investment Trust has given investors a total return of 222 per cent over the past decade, while the 3i Group trust has returned 938 per cent.
It's not that I didn't understand dividends before this moment or hadn't looked at the yield on offer when it came to investment trusts, but I don't think I had quite comprehended just how much dividends can fuel growth over the long term. I admit that, as someone looking for capital growth over income, I had somewhat overlooked their power.
Dividends are paid out by companies as a way to redistribute profits and reward shareholders. They are often paid quarterly and in cash, and companies typically use them to keep investors happy and to entice new ones.
Companies that choose to retain their profits and reinvest in the business, instead of dishing it out to shareholders, tend to be known as 'growth stocks'. Investors who opt for growth stocks are more focused on capital growth over time than money today.
As an investor, you can get dividends by holding shares in companies that pay them, or by investing in a fund or investment trust that invests in dividend-paying companies.
• Dividend tax to affect record 3.7m investors after allowance cut
Those looking for an income may have their dividends paid into their bank account (this is particularly popular for those in retirement), but you can also opt to have your dividends reinvested — each time a company pays out, your own investment in that company gets topped up. And this is where they can really help to boost your portfolio.
'Even if you don't need the income, dividends can be a fantastic way to compound returns if you reinvest the dividends and take advantage of pound cost averaging. Reinvested dividends can make a huge difference to the overall value of your portfolio,' said Helen Bradshaw from the wealth manager Quilter. Pound cost averaging is when you buy shares regularly, which averages out the cost of the shares, and helps to smooth stock market volatility.
Susannah Streeter from the investment platform Hargreaves Lansdown said: 'When it comes to building wealth, dividends can be a powerful ally, especially if they accumulate over the long term.'
Sums from Schroders, the fund manager, show the impact that dividends can have. Say you invested £1,000 in company A and £1,000 in company B. Company A's share price goes up 5 per cent a year — happy days — and has a dividend yield of 1 per cent. Company B's share price goes up 3 per cent a year but pays out a 5 per cent dividend.
If all dividends were reinvested your holding in Company A would be about £3,240 after 20 years, but your holding in Company B would be worth nearly £4,800.
Unfortunately for investors trying to pick a stock it's not simply a case of closing your eyes and pointing at the highest yielding company.
A company's dividend yield is calculated by dividing its dividend in pounds and pence terms by its share price. For example, if a business paid out 50p a share in dividends and its share price was £10, it would have a dividend yield of 5 per cent.
This means that an investment with a high dividend yield could simply have a weak share price. In this scenario, it is likely that the dividend payment is too high and the market has already priced in that it will be cut in the future.
Any fall in the share price would also automatically raise the dividend yield. If we use the same numbers as above, if the company's share price dropped to £8, its 50p per share dividend would give it a yield of 6.25 per cent — but not for a good reason.
Richard Hunter from the fund platform Interactive Investor suggested looking at dividend cover to see whether a dividend payout was sustainable. Dividend cover is a ratio of how many times the available profits can cover the total dividend payout. A number of 1.5 or above, meaning the profits are 1.5 times dividends, is considered a comfortable level.
As a general rule of thumb, a 'good' dividend is in the ballpark of an average savings rate on cash — today, that's about 2.4 per cent. By comparison, the FTSE 100 (the UK's main stock market) has an average dividend yield of about 3.3 per cent, while the S&P 500's average (the US's equivalent) is about 1.2 per cent.
James Burns from the advice firm Evelyn Partners said: 'The UK is generally a good place for those seeking dividend income as it has many sectors that are highly cash generative. Oil companies, tobacco stocks and insurance companies have all been popular with income investors.'
In terms of dividend-paying stocks, Streeter recommended National Grid, which has an expected dividend yield of 4.5 per cent, and Legal and General, which is set to pay about 8.4 per cent. NatWest has a forward dividend yield of 5.4 per cent.
I only have one strong dividend payer in my portfolio: Mitsubishi Financial Group, a Japanese banking institution that pays 2.74 per cent. The rest of my investments barely reach 1.5 per cent.
My new-found respect for dividends isn't going to overhaul my investment strategy or prompt me to sell any holdings, but next time I choose a new investment, I'll certainly pay slightly more attention to the yield (and dividend cover) on offer.