Where do dividend cuts leave income-hungry investors?

15/04/2020

The coronavirus pandemic is claiming more and more corporate victims. At a time when economies have ground to a halt, companies are doing what they can to survive.

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Saving cash is a priority. Perhaps inevitably, many company dividends are now being cut amid the coronavirus shutdown.

The roster of well-known UK companies that have suspended or scrapped their dividends to shareholders in early 2020 includes broadcaster ITV, retailer Marks & Spencer, and British Airways owner IAG.

Most significantly, in terms of value, the UK’s largest banks agreed in concert to cancel their upcoming dividends. Barclays, HSBC, Lloyds Banking Group, the Royal Bank of Scotland and Standard Chartered announced they would not be paying distributions this year, meaning their shareholders will miss out on roughly £15 billion in income.

A short-term hit for income investors

These dividend cuts will affect many investors who specifically target regular pay-outs from their shareholdings.

For those relying on dividends to top up their income, or to help fund their retirement, it could be especially painful if distributions dry up. After all, dividends are often a key source of the income that you can generate from investments, alongside coupons from holding bonds and rent from owning property.

Dividends have arguably become an especially important source of income over the past decade or so, when the interest rates available on cash savings have been at record lows in the UK and elsewhere. With the Bank of England cutting base interest rates to an all-time low of 0.1% this March, it looks unlikely that savers will be able to generate much of a return on cash for the foreseeable future.

It is important to remember though that up to £85,000 of your money is secure in a bank or building society through the Financial Services Compensation Scheme, unlike stocks and shares or fixed interest investments which are less secure.

How to target a robust investment income

Companies cutting dividends is a good reminder that there are no guarantees when it comes to investment income, especially from dividends. As we have recently seen, company management can choose to reduce or stop distributions at any point, as fortunes dictate.

For dividend investors, the risk of disappointment can be mitigated by not relying on any single company for income. Indeed, it’s sensible not to rely on any single area of the stockmarket such as banking or the energy sector, the latter of which can be heavily dependent on global oil prices.

By diversifying across different types of companies – perhaps beyond only those listed in the UK – you could cast the net wider for dividends and reduce your exposure to a downturn in any one corner of the global stockmarket.

There are actively managed funds that aim to deliver resilient incomes from dividends for their investors. Fund managers might look to selectively invest in companies able to withstand difficult conditions like this, perhaps because of the strength of their balance sheet or business model, and so be better able to continue paying dividends.

Certain funds target a diversified income stream that is more resilient to market fluctuations by investing across a wider range of income-bearing assets, including bonds and property too.

Of course, while each fund aims to achieve its objective in any market conditions, there can be no guarantee since the value of investments, and the income from them, will fluctuate over time. As with any investment, you may not get back the original amount you invest.

The fundamental appeal of dividends

Disappointing as dividend cuts might be, we must remember that they are not a sign that a company is failing. In fact, in many cases, cancelling distributions and keeping cash in the business will probably be in the interests of long-term shareholders.

As and when economic activity rebounds following the gradual unwinding of stay-at-home policies, more robust businesses should again be in a position to resume paying dividends.

For dividend investors who are confident that the global economy will recover, the sell-off in company shares could mean there are opportunities to buy into long-term dividend streams at a more compelling entry point than before the recent downturn.

Please bear in mind that M&G is unable to give financial advice. The views expressed here should not be taken as a recommendation, advice or forecast.

The value of any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.