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Why equity income investing is a good way to grow your money

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Investing in stable, well-run businesses that pay healthy dividends can be a good way to turn your savings into income.

by Gavin Lumsden on Sep 28, 2012 at 16:30

Why equity income investing is a good way to grow your money

Equity income investment is a classic way of making money from the stock market. It's all about buying shares in well-managed companies that pay good dividends to their shareholders.

If you are a DIY investor you can build a portfolio of income stocks on your own, or alternatively you can invest in one of the many equity income funds available.

In this video Gavin explains how dividends can help turn your savings into an income stream.

Hello and welcome to the Lolly Investor Programme.

Well the summer is definitely over!

As I thought about this week’s topic all the wet weather we’ve had reminded me of the nursery rhyme about Incy Wincy spider.

Incy Wincy shows great resilience as she climbs up the spout again and again after each shower of rain.

Just like investors! In the past 12 years investors have been washed away by a series of downpours culminating in the biggest soaking of them all in the 2008 financial crisis, from which we are still recovering.

After each shower comes the sun, however.

And drying up some of the rain for investors in recent years has been the re-emergence of a classic way of investing in the stock market.

It’s called equity income and it’s what I want to talk about today.

Equity income investing is about buying shares in well-managed companies that pay good dividends to their shareholders.

Good doesn’t necessarily mean big. It means dividends that are sustainable and that grow above inflation.

If you are a DIY investor you can build a portfolio of income stocks on your own.

Alternatively you can invest in one of the many equity income funds available, which will do the job for you.

The great news for investors is that companies in the UK generally have a good attitude towards paying dividends to their shareholders. 

And the dividend culture is spreading. The US, not surprisingly, is also pretty good at looking after shareholders, while Europe and Asia are getting better.

This means there is a growing number of global equity income unit trusts and investment trusts to choose from, as well as the UK equity income funds investors have traditionally used.

Dividends are a crucial part of the total return investors can get from the stock market if they reinvest them.

£100 invested in the UK stock market after the second world war would be worth around £7,400 today if you had taken the dividends and spent them.

But if you had reinvested those dividends back into the stock market that £100 could have been turned into over £130,000.

Here’s another statistic.

The UK stock market has generated an average annual return of nearly 5% over inflation since 1970.

Most of that, around 4%, has come from the initial dividend yield investors would have got when they invested 42 years ago.

Let’s remind ourselves about dividend yields.

The dividend yield is a percentage that measures how much dividend you get for each share you own. 

Dividend yields move in the opposite direction to share prices. So if a company’s share price falls and gets cheaper and if it maintains the level of its dividend then the yield will rise.

The higher yield means you’re buying more dividends when share prices are low.

In other words we’re back to the fundamental rule of investment that you should buy when prices are low and sell when prices are high.

This leads me to a second piece of good news for investors.

The UK stock market is relatively good value at the moment.

One measure of this is that the FTSE All Share index currently yields 3.6%. Meanwhile the yield on UK government bonds, traditionally an important source of reliable investment income, is only around 1.3%.

In other words government bonds are expensive, shares are quite cheap.

Moreover, many big companies are cash rich and should be able to continue growing their dividends above the rate of inflation, unless we fall back into a really serious recession.

To sum up now is a really good time to get into equity income investing.

If you are a younger person wanting to grow your money over the long term the equity income approach is a tried and tested means of generating a good total return.

If you’re older and want to take the income, equity income funds are a good solution, although there is always the risk that a big stock market crash will make a big dent in your capital.

Like Incy Wincy there is always the chance that markets will send you tumbling again.

11 comments so far. Why not have your say?

SammyB

Sep 30, 2012 at 17:13

Where can investors get reliable data on Income producing INVESTMENT Trusts?

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ian humphries

Sep 30, 2012 at 22:11

The Quarterly Investment Trust magazine, out again at the end of October.

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ian humphries

Sep 30, 2012 at 22:13

or goggle "TRUSTNET"

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Digger

Oct 01, 2012 at 12:16

Trust net excellent yes, and Money Observer I find good too, they do a quarterly IT seperate mag with excellent stats.

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Clive B

Oct 01, 2012 at 12:45

Trustnet:

http://www.trustnet.com/Home.aspx

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Richard W Green

Oct 01, 2012 at 13:05

When you're looking for an investment trust for income have a look at how much of their expenses are charged to capital and also what their portfolio yield is. Some have been quite aggressive and have little room left whilst others like Alliance pass all their expenses through their revenue account. The amount they charge to capital you'll have to work out yourself, but the portfolio yield can generally be found in the AIC's MIR figures (available from their website). There are examples of trusts where the dividend yield is higher than the portfolio yield. Think about it!

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uo

Oct 01, 2012 at 13:53

not an expert.so wellcome all suggestions.ie where can i invest funds ,shares or investment trust

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talbot

Oct 01, 2012 at 15:16

You can get research from The Association of Investment companies

www.theaic.co.uk and it is free

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Dividend Income investor.com

Oct 01, 2012 at 16:01

With regards to individual dividend paying FTSE350 shares, see:

www.dividendmax.co.uk

www.dividend-income-investor.com

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Hotrod

Oct 01, 2012 at 17:37

A very good piece by way of introduction to the stock-market in as much that in order to succeed you must persevere with a chosen strategy and not be put off when confronted with temporary setbacks, however I would not have used this analogy to suggest a suitable starting point.

In my opinion "Incy Wincy" was not a particular savvy spider. If he was he would have realised that drain pipes are too risky to use as a safe haven. He was in the dark and would have no idea what was likely to happen. Also there would be no food in there. Flys do not venture into drain pipes, and yet he persisted in making strenuous efforts to climb back up despite the fact that he had been flooded out and nearly drowned.

It's the same with the stock-market, there are an awful lot of financial drain-pipes which you have to learn not venture into.

When I started investing people did not have computers in their homes and the internet had not yet been invented, so in order to familiarise myself with stocks and shares I bought the Financial Times and Investors Chronicle. I must say that most of what was written was way above my head and there was very little information that I understood enough about to give me the confidence to invest, so I decided to adopt a simpler method. I was employed as an engineer and used copious amounts of lubricating oil in my work, so it seemed like a logical starting point. But which company? In order to find out, whenever I went into a filling station, garage, or vehicle parts shop, I counted the number of cans of oil on the shelves. After a short while I was able to calculate ratios and make an estimation of respective market share.

I followed a similar system with bakers shops, builders merchants and engineering businesses. The strategy was successful, but I was also lucky because it was a time of rapid industrial growth.

As Gavin pointed out, the investment climate changed dramatically in 2008 therefore different oppertunities require different methods of detection. One of those methods may be chart analysis, You can study company performance in chart form on most financial internet sites. Charts become more and more revealing as experience grows.

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Squareblade

Oct 01, 2012 at 17:42

I have found Shires Income and Merchant Investment Trusts to be good income producers which invest in major defensives. Also Invesco Leveraged Income (ILH) which gears up the income from Corporate Bonds. As always, do your own research.

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