October 2021

After a horrible 2020 for dividend paying companies, this year has been an encouraging return to form. Investors can’t afford to ignore the benefits of reinvesting dividends.

Good news: the COVID-induced dividend drought appears to be over. After a terrible 12 months, when most dividend-paying companies in the financial services, property, and oil and gas sectors were forced to suspend or drastically reduce dividend pay-outs to shareholders, 2021 has seen a sparkling recovery.

Dividends are usually considered to be a good sign that a company is doing well, and has plenty of spare cash in the bank. But the UK’s reputation for dividend payments took a battering during 2020 thanks to the COVID-19 pandemic, forcing companies to take widespread and often drastic measures to keep operating during a period of uncertainty. As a result, last year the FTSE 100 average dividend yield for 2020 overall ended up at a significantly lower 2.98%, and total dividends paid to investors fell to £61.4 billion. However, stockbroking firm AJ Bell expects FTSE 100 dividend payments to bounce-back to an impressive £85.1 billion this year, just short of the record-breaking peak of £85.2 billion in dividend pay-outs set in 2018.

Dividend tax is on the increase

Of course, the downside is that the government has now introduced a 1.25% increase in dividend tax to help pay the bill caused by COVID-19, and to increase spending on health and social care. As a reminder of the government’s tax plans, investors can still earn up to £2,000 in dividends before they are liable for any tax. But beyond that threshold, basic rate taxpayers can expect to pay dividend tax at a rate of 8.75% from the 2022-2023 tax year. Higher rate taxpayers will see their dividend tax rate increase to 33.75%, while additional rate taxpayers (earning more than £150,000) in England will pay dividend tax at 39.35%. It’s worth remembering that investors do not pay any dividend tax on money invested in an Individual Savings Account (ISA), which is why it’s essential to always use up your tax-free ISA allowances.

Why it pays to reinvest dividends

Dividend paying companies are very attractive within any investment portfolio, but you don’t have to collect the regular dividend payments. In fact, it’s well worth using the dividends instead to purchase additional shares – which in turn also pay out future dividends. This is known as the power of compound interest.

Here’s a quick example to show what we mean. You buy 100 shares in a company at a cost of £1,000. The company pays a dividend of £6 every year for ten years. Instead of pocketing the cash, you reinvest your dividends and you use the money instead to buy more shares in the company. As time passes, a dividend reinvestment strategy starts to become the largest contributor to total return. The more dividends you reinvest, the higher your future dividend payments.

Take the following example of the FTSE100 index over the last 20 years (see graph below). The red line shows the pure performance of the index, not taking any dividend income into account. As you can see, the index value has increased by more than 40% over the last 20 years.

However, this performance is a fraction of the total return achieved over the same period, when dividend income from the FTSE100 constituents is reinvested. You can see the total return including reinvested dividends, shown in blue, has returned 193% over the same 20 year period, almost five times the return of the raw index.

The effect of compound interest on reinvested dividends is more powerful the longer you invest, as it multiplies the available returns on the original investment. Over time, the dividends reinvested in the early years have the largest impact on total returns, and you stand to benefit not just from the increased value of the company’s shares, which may fluctuate over time, but also from the larger shareholding as you’ve used the dividend proceeds to buy more shares, which means more dividend proceeds, and so on. It’s a great way to increase the value of your investment without lifting a finger.

Last thoughts

Of course, dividend payments received by investors are still liable for dividend tax, even if they are automatically reinvested. But for the time being, investors still have a dividend allowance of £2,000, which means for the first £2,000 of any dividends you receive you don’t need to tell HMRC or record the dividends on your self-assessment form.

If you’re unsure whether your investments will mean you pay dividend tax, please get in touch. We’d be happy to provide you with a report on your dividend situation, as well as recommending ways to get the most out of your tax-free allowances. You may not be able to avoid paying dividend tax, but we can help to make sure you get the best value from the dividends you earn on your investments.

If you are interested in discussing your investment strategy with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

Investment Pathways for Retirement Planning is a new initiative launched by the Financial Conduct Authority (FCA) in February 2021, designed for people who wish to draw their pension under a Drawdown arrangement, without first obtaining regulated financial advice. As we will explore, one size does not fit all, and forging your own bespoke path, whilst taking ongoing advice, may well lead to better outcomes.

Taking a flexible approach

Flexi-Access Drawdown is an alternative to the purchase of an annuity, which provides much greater flexibility in terms of how income is drawn in retirement. It is increasingly popular, as it can offer the potential for individuals to use their pension savings to best fit their needs and objectives, but unlike a pension annuity, does not provide a guaranteed income for life. As the pension fund continues to be invested throughout retirement under Drawdown, investment decisions and careful management of the fund are critical components of a successful Drawdown approach. Personal responsibility for the long-term viability of the pension drawdown plan rests with the pension holder, hence the importance of receiving initial advice on the level of income drawn and investment options, and reviewing the plan regularly to ensure that it continues to meet the initial objectives.

Choose a Path?

The idea behind Investment Pathways is to create four default investment routes for individuals who have already taken Tax Free Cash from their pension, leaving the remaining funds in Drawdown. The FCA hope the initiative will reduce the number of individuals, who decide to enter Drawdown without receiving advice, making poor investment decisions, such as leaving significant funds in Cash for the long term, or taking excessive investment risk.

Four Paths have been defined, with the first being aimed at those who have no intention of drawing an income in the next five years. This strategy is largely aimed at growth over the medium term. The second Path is designed for those who wish to purchase an annuity in the next five years and will aim to preserve capital. The third is for those who are considering drawing income in the medium term and will aim to provide a balanced approach. The final Path is for those who are looking to draw the full value of their pension in the next five years, and again aims to preserve the capital value.

For each defined Pathway, pension providers will produce a ready-made investment portfolio which aims to meet the objective of the Pathway, which is where we feel the proposals may begin to fall short of their objectives.

The majority of providers offering these Pathways are using a single passive investment fund, with no ability to vary the investment options within the Pathway selected. This limits the scope for an individual to select alternative funds within an individual Pathway, or to access funds that meet their own preferences, for example, to invest in a socially responsible manner.

Bespoke is best

But more importantly, the Pathways do not take into account an individual’s financial circumstances, objectives or attitude to investment risk. This is a vital element of the advice process that is missed by using this automated approach. Take an individual who prefers to take a cautious approach to investment as an example. They choose the third of the fourth automated pathways, as they are considering drawing income from the pension in the next five years. In this scenario, they could experience an increase in investment risk and volatility over their existing arrangements they held before entering the Pathway approach, which they may not be aware of, or may be contrary to their wishes.

Conversely, an individual who chooses the Pathway towards taking the full value of their pension in the next five years (option four) would be placed largely in a Cash fund with most providers, where negative real returns are more than likely to be achieved when charges, and the eroding effects of inflation, are taken into account. We don’t imagine someone who is planning to draw their fund out in five years’ time will be pleased to be missing out on the potential for investment returns over this period, even if they were taking a cautious investment approach.

Tailored to your needs

We understand the Regulator’s concerns. Without proper advice, individuals could leave their pensions in Cash over the longer term or take excessive risk with their pension arrangements, neither of which are likely to be appropriate. However, we feel that Investment Pathways are too rigid and inflexible for most individuals with at least modest sized pension plans, who are considering Flexi-Access Drawdown as an approach to retirement planning. For these individuals, we believe that Investment Pathways are no substitute to taking an alternative path, via independent advice, that is tailored to their own circumstances and objectives. Furthermore, regular reviews of any Drawdown are of high importance, to ensure the approach remains appropriate to any future change in circumstances.

If you are considering your retirement planning and would like to discuss your options with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice. 

Since the advent of electronic day trading, it has become increasingly popular among do-it-yourself investors to trade stocks on a short-term basis, hoping it will lead to spectacular returns. But trying to time the market is a risky gamble where the odds are seldom in your favour.

We’ve probably all thought about what life could have been like if we had invested a few thousand pounds the day after the ‘Black Monday’ stock market crash in 1987, or after the global financial crisis in 2008, or even during the lowest point during the COVID-19 pandemic in March of 2020 when stock markets fell heavily due to concerns about the global economy shutting down. These are the kind of hypotheticals that get people excited about the rewards associated with investing, and they are all examples where ‘timing the market’ would have paid off handsomely.

What is ‘timing the market’?

Timing the market is an investing strategy where investors hope to make profits by identifying the best times to buy investments, and the right times to sell them. The most popular advice associated with timing the market is the well-worn catchphrase: “buy low, sell high”. While that advice isn’t wrong exactly, the difficulty with trying to follow it is this: how can you be sure of when prices are low enough to buy, and high enough to sell? The simple answer is you don’t. You can only make a judgement based on your limited knowledge at the time. Just because you think something is priced at its absolute lowest, that doesn’t mean it won’t get any lower. Similarly, plenty of people have sold stocks at a point where they felt their value couldn’t get any higher, only for it to do precisely that.

The other great piece of advice about market timing comes from Warren Buffett: “Be fearful when others are greedy, and greedy when others are fearful”. The challenge with this wisdom, of course, is that it’s incredibly hard to do the exact opposite of what everyone else is doing.

Is timing the market achievable?

Cheerleaders for timing the market will tell you that it is possible to forecast the highs and lows of investment markets and that doing so will result in greater investment returns than available through more conservative strategies. However, in our view, timing the market is a risky strategy that leaves investors potentially exposed to volatility and unpredictable events that a more sensible investment approach will navigate relatively easily. At FAS, we work closely with our clients to help them grow their wealth by staying invested in the market, and we discourage our clients from thinking they can simply buy and sell their way towards long-term wealth.

Why is timing the market risky?

One of the biggest downsides to timing the market is that the timing is fiendishly difficult to get right. Getting it wrong means potentially missing out on the days when being invested in the market works firmly in your favour.

One of the most common market timing ‘missteps’ DIY investors often make is to pay attention to negative headlines and sell their equity investments ahead of an expected market ‘correction’ (a correction usually occurs when investments appear overvalued and subsequently fall by more than 10% but less than 20%). But the timing of a correction is never easy to predict. While the investor is sitting on the sidelines waiting for markets to fall, they could be missing out on a period when investments continue to rise.

This market timing error is often compounded by the investor – who has grown increasingly frustrated at missing out on returns – deciding to jump back in and start rebuying equities at the higher prices, only to then suffer even greater losses when the correction occurs. In such instances, staying invested and riding out the correction would have been a wiser, more profitable – and less stressful – course of action!

So what’s the alternative?

In our view, buying and holding a well-diversified collection of investments is a much more effective strategy over the longer term, and the research confirms it. A recent study by investment firm Schroders calculated the benefits of staying invested in the market over long periods, compared with attempting to time the market by dipping in and out. Their research included looking at the performance of the FTSE All-Share and FTSE 250 indices since the beginning of 1986.

If an investor had invested £1,000 evenly across the companies listed on the FTSE 250 back then and held their investment to January 2021 (a 35-year holding period) according to Schroders that grand could have been worth £43,595. Over the same period, if the investor had timed the market, and missed out on the FTSE 250’s best 30 days, Schroders estimated the same initial investment would be worth just £10,627, a shortfall of £32,968 (not adjusted for the effect of investment charges or inflation).

Schroders also revealed that buying £1,000 of FTSE All-Share stocks over the same timeframe would have resulted in the investment increasing in value to £19,452 provided it was held throughout the period. Alternatively, dipping in and out of the market, and missing out on the best 30 days means that £1,000 would only be worth £4,264 some 35 years later.

Of course, no one has a crystal ball that can tell them whether tomorrow will be one of the best days or worst days. And the irony with stock markets is that many of the ‘best’ days in return terms have followed shortly after some of the worst. That’s why the most sensible approach, and to prevent you from missing out on valuable potential returns, is to stay ‘in’ over the longer term, along with reviewing your investments regularly to check on their progress.

Staying the course

So, when it comes to managing your wealth, and investing with the aim of achieving long-term objectives, we think it’s important to take luck out of the equation, and that ‘staying the course’ will give you every chance of success. Choosing to ‘buy and hold’, doesn’t mean ignoring your investments, instead it’s about having a plan and sticking to it, even when things look rocky. The best way to do that is to agree on a long-term financial plan with us, that gets reviewed on a regular basis to ensure it remains on track.

If you are interested in discussing your investment strategy with one of our experienced financial planners at FAS, please get in touch here.

This content is for information purposes only. It does not constitute investment advice or financial advice.