The first dividend income from the high yield portfolio [1] (HYP) I set-up in May has already begun trickling into my clammy hands!
More precisely, the dividend income has been paid into the Halifax Sharebuilder account where I hold the portfolio. It will stay there until I withdraw it.
So far I’ve received a total of £14.50 in income, paid by four constituents: Royal Dutch Shell, Aberdeen Asset Management, Unilever, and Admiral. Not much of a haul from the £5,000 I invested but it’s early days. A full 16 companies are yet to make any payment, and all pay at least twice a year.
I calculate the HYP’s starting forecast yield to be around 4.3%. Therefore, we might expect at least £215 over a full 12 months to 6th May – though in the first year it’s certain to fall below that because some companies would have been trading ex-dividend when I jumped into these shares, and other payments due won’t actually make it into my account until the second year.
What I’ll do with the dividend income
As previously explained, I do not intend to reinvest the dividend income from this demo HYP [2] back into these shares.
Partly that’s to reinforce a point: I think HYP’s are best thought of as income vehicles, rather than as necessarily a good route to growing a capital sum (although that said there’s nothing wrong with targeting income [3] from day one and avoiding onerous switching costs and hassle later on, even if it’s potentially not a winning strategy in total return terms. There’s more than one way to skin cats).
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in…”
– J.D. Rockefeller.
I’m also not reinvesting these small amounts of dividend income because I want to avoid the tedious paperwork [4] associated with reinvesting dividends outside of an ISA should I ever need to calculate capital gains tax [5] on the shares.
But mainly I want to ‘cleanly’ see what my initial £5,000 investment is paying out in a few year’s time, and to judge if it has achieved my target of delivering more cash in real terms (that is, inflation-adjusted) than today.
This will be trivially easy to see if I simply keep the capital investment intact, and then add up and withdraw all the income every year. I’ll report the annual dividend income sum here on Monevator, and we can ponder what a fully scaled-up equity income portfolio might mean for a pensioner currently trying to get by on a squeezed and cheapened fixed income.
Dividend income is key to long-term returns
Now, if you’re a long-term investor in the stock market, you should certainly be reinvesting your dividend income.
This is super-simple with Halifax Sharebuilder, and it only charges you 1% of the sum being reinvested. (So 10p on automatic reinvestment of £10). 2% of the sum being reinvested (so 20p on an automatic reinvestment of £20). (The charge went up to 2% since I wrote this – see Martyn’s comments below).
Alternatively you could allow the dividend income to add up until you’ve got enough money to make another share purchase efficiently after dealing charges. I’d probably do this myself, to take the HYP to 30-odd shares, before I began to reinvest in existing holdings.
However you choose to reinvest your money from shares, make sure you do it if you’re under 60. Dividend income is extraordinarily important. While the financial media goes crazy for daily share price moves, it’s the compound impact of reinvesting dividend income over the decades that has generated the bulk of the stock market’s winning longer-term performance.
According to the infamous Barclays Equity Gilt Study 2011 edition of historical returns [6]:
- £100 invested in UK equities in 1899 would have been worth just £180 by the end of 2010, after inflation. That’s barely doubled!
- In contrast, if you’d reinvested your dividends over the same time period, you’d have been left with an after-inflation sum of £24,133!
Spending your capital is a sin, just like the old-timers said. But spending your income too early isn’t going to lead to a heavenly retirement, either.
A fudge to track the HYP’s total return
Given the importance of dividend reinvestment, what I may do is track the year-end capital value of the demo HYP in a spreadsheet (and in an annual review on Monevator!) and then assume I reinvested that year’s dividend income into buying a fresh chunk of that same portfolio.
I’ll knock off 1.75% of the total cash amount (note: not the running yield [7]!) of dividend income being reinvested to account for fees, spreads, and stamp duty.
For example, if I get £200 of dividends over the year, then I’ll assume £3.50 is lost to costs and add the remaining £196.50 to the ongoing portfolio value.
The next year I can simply calculate the yield due on that sum based on the actual return from the real-money portfolio, and compound again. Unless I’m missing something obvious, this should give a rough handle on how the portfolio would be growing if the money wasn’t being withdrawn to spend on whisky and women (or more likely Kindle books [8] and Marks & Spencer canapes).
Obviously it won’t produce exactly the same result as reinvesting dividend income throughout the year would, but it will serve as a decent approximation and anomalies should balance out over time.