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A balanced investment portfolio needs both power and control. A source of growth, but with an awareness of risk. Investing for growth and income in a portfolio can be a way to provide this balance, creating resilience, while sustaining long-term investment returns.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Investors look to the stock market to help their savings grow faster over time. However, stock market investment comes with risks, and share prices can be volatile. Introducing an income strategy could be a good option for investors that want both financial stability and wealth accumulation, such as those in retirement.
Income from the stock market
Stock market returns can have three constituent parts – dividend yield, dividend growth and the change in share price that occurs while an investment is held over time. Of these three component parts, dividend yield is the most tangible. Companies will often return a portion of their profits to shareholders in the form of a dividend. This is not guaranteed, but all but four of the companies in the FTSE 100 currently pay dividends to shareholders.1
The alternative is for companies to redeploy the profits in the business, launching new products and services, buying new equipment or hiring new staff. This can be a pathway to growth, and may improve the share price over time, but it is inherently more uncertain than a dividend payment.
Dividends can be an important discipline for a company. These companies will still have risks, and dividends are not guaranteed, but if companies have strong enough cash flow to pay a dividend, it can be an indication of stability. Equally, if companies are committed to paying a dividend, it could mean they are not engaging in risky acquisitions, or exploring speculative new product lines. Dividend payments tend to be a feature of mature businesses with predictable earnings and cash flow, which may be lower risk investments.
This is why investing for income can bring some stability to investment returns. Investors know that if a company continues to make profits, part of their return may come back to them as a dividend.
Compounding dividends
Over time, dividends have been a powerful part of the overall returns from stock market investing, particularly in certain markets. It is worth noting that since the turn of the century, the annualised increase in the FTSE 100 index (or ‘price return’) has been just 0.4%, add in reinvested dividends and the annual total return rises to 4.1% per annum over the same period.2 The price return is the increase in the level of the index, while total return takes in dividends as well.
Reinvesting dividends to buy more of a particular investment can be a powerful way to harness the power of compounding. For example, if an investor has a portfolio of shares worth £10,000, paying annual dividends of 3%, and reinvests those dividends over 10 years, they will earn £300 in year one (3% of £10,000).3 Ignoring any share price appreciation, that means their investment would grow to £10,300. If the dividend grew at 3% again the next year, the investment would earn £309, and the investment would now be worth £10,609. After 10 years, dividend increases alone would have raised that initial investment to £13,493,4 even if there is no appreciation in the share price.
This also works at the level of individual companies. Among the BlackRock Investment Trusts, for example, the BlackRock Sustainable American Income Trust aims to select high quality, income generative companies from across North America with the power to compound their growth over many years.5
Dividend growth
Another important contributor to equity market returns historically has been dividend growth. Companies can grow their revenues, profits and earnings over time, and this could allow them to make higher dividend payments to shareholders. This is in contrast to the income from cash or fixed income, which, for the most part, is static and does not grow with inflation. Inflation can be corrosive for long-term savings. £10,000 invested in September 2004 would have had to grow to £20,8006 by September 2024 just to have the same purchasing power.
It is important to note that dividend growth is not guaranteed. Sometimes companies are forced to cut their dividend or pass on them altogether, because their profits or cash flows cannot sustain their payouts. Indeed, in challenging economic conditions – such as those seen during the global financial crisis or the Covid pandemic – the aggregate level of dividends across an entire market may decline.
Nevertheless, history suggests that dividends do rise over time, albeit rarely in a straight line. The reason for this is that companies have what is known as “pricing power”, the ability to raise prices over time. This comes in to its own in times of higher inflation and it is one of the main reasons equities have historically done well through inflationary periods such as the 1970s.7
The BlackRock Income and Growth Trust, for example, places great importance on the ability of a company to raise its dividends over time. In the portfolio manager’s current process (which is subject to change without notice), it does this by looking at three main types of company. The first segment is ‘income generators’. These comprise 70% of the portfolio, and are companies with high and sustainable cash flow and a growing dividend. This might include companies such as Relx or AstraZeneca, all long-standing holdings for the trust.8
It also has 20% of the portfolio in ‘growth’ companies that have significant barriers to entry and scalable business models that enable them to grow consistently. This might include companies such as private equity and infrastructure specialist 3i Group7. Turnaround companies - those companies that are out of favour with the market, facing temporary challenges yet offer significant recovery potential – are 10% of the portfolio.
Reference to Specific Stocks: Reference to the names of each company mentioned in this article is merely for explaining the investment strategy, and should not be construed as investment advice or investment recommendation of those companies.
Why investing for growth is also important?
Dividends are important, but there are some nuances. A very high dividend yield can be a sign of distress. The dividend yield is expressed as a percentage of the share price. Therefore, if the share price falls, the dividend yield will rise – a company with shares trading at £50, with a £2.50 dividend has a yield of 5%, but if the shares drop to £40, that £2.50 dividend is equivalent to a yield of 6.25%. Very high yields can be a sign that the market is worried about the company and believes it may cut its dividend in future. Therefore, investors cannot ignore a company’s potential growth in deciding whether its dividend is sustainable.
Investing for capital growth as well as income can also help introduce new and dynamic sectors into a portfolio.. It can even bring in new and interesting markets: this is the case for the BlackRock Frontiers Investment Trust, which targets small, growing economies around the world. This can make for better diversification.
The flexibility that comes from introducing a growth element to a portfolio can also be important in harnessing structural changes in the global economy.
Diversification: Diversification and asset allocation may not fully protect you from market risk.
Who does this approach work for?
Balancing income and growth is a good option for people who need an income from their investments, but want to retain the capacity for capital growth. It can be a useful strategy in retirement, for example, where people will need an income to support their day to day living requirements, but also need their capital to keep pace with inflation. It is important to note that those who take the income from their investment will not benefit from compounding in the same way as someone who reinvests their dividends.
Balancing income and growth is also a good option for those that want a lower risk approach to stock market investment. The most important element for any stock market investment is to remain invested over time. ‘Time in the market’ has been more important than ‘timing the market’. Investors are generally poor at moving in and out of the market at the right time, tending to invest when markets are high, and pull out when markets fall.9 This can lower their share price returns over time. A balanced portfolio can give a smoother journey, helping keep investors in the market, which is good for their long-term wealth.
Dividend investing is a vital part of long-term wealth generation and can bring some stability to investment returns. However, looking at the potential growth is important as well, helping to identify those companies that could grow their dividends and share prices over time.
1 Dividend Data, Dividend Yields - FTSE 100, 30 September 2024
2 IFA Magazine - FTSE 100 celebrates 40th birthday – but is it over the hill? January 2024
3 Dividend Data, FTSE 100 Index Dividend Yield - 3.49%, 30 September 2024
4 This is Money - Monthly lump sum savings calculator - September 2024
5 The AIC, BlackRock Sustainable American Income, dividend history, 30 September 2024
6 Hargreaves Lansdown - Inflation calculator - September 2024
7 BlackRock - The Importance of income to total return - November 2023
8 BlackRock Income and Growth Investment Trust - BlackRock Income and Growth Investment Trust plc
9 Businesswire, DALBAR Releases 30th Annual QAIB Report, 11 April 2024
Risk Warnings
Investors should refer to the prospectus or offering documentation for the funds full list of risks.
Capital at risk. The value of investments and the income from them can fall as well as rise and are not guaranteed. Investors may not get back the amount originally invested.
Past performance is not a reliable indicator of current or future results and should not be the sole factor of consideration when selecting a product or strategy.
Changes in the rates of exchange between currencies may cause the value of investments to diminish or increase. Fluctuation may be particularly marked in the case of a higher volatility fund and the value of an investment may fall suddenly and substantially. Levels and basis of taxation may change from time to time and depend on personal individual circumstances.
Fund-specific risks
BlackRock Sustainable American Income Trust plc
Capital Growth / Income Variation: Investors in the Fund should understand that capital growth is not a priority and values may fluctuate and the level of income may vary from time to time and is not guaranteed.
Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.
Derivative Risk (Derivatives, Options, Covered calls): The Fund uses derivatives as part of its investment strategy. Compared to a fund which only invests in traditional instruments such as stocks and bonds, derivatives are potentially subject to a higher level of risk.
Derivatives Risk: Derivatives may be highly sensitive to changes in the value of the asset on which they are based and can increase the size of losses and gains, resulting in greater fluctuations in the value of the Fund. The impact to the Fund can be greater where derivatives are used in an extensive or complex way.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Investment Trust Disclaimers: Net Asset Value (NAV) performance is not the same as share price performance, and shareholders may realise returns that are lower or higher than NAV performance.
BlackRock Income and Growth Investment Trust plc
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Liquidity Risk: The Fund's investments may have low liquidity which often causes the value of these investments to be less predictable. In extreme cases, the Fund may not be able to realise the investment at the latest market price or at a price considered fair.
BlackRock Energy and Resources Income Trust plc
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.
Emerging Markets: Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Investments in Mining Securities: Investments in mining securities are subject to sector-specific risks which include environmental concerns, government policy, supply concerns and taxation. The variation in returns from mining securities is typically above average compared to other equity securities.
BlackRock World Mining Trust plc
Counterparty Risk: The insolvency of any institutions providing services such as safekeeping of assets or acting as counterparty to derivatives or other instruments, may expose the Fund to financial loss.
Currency Risk: The Fund invests in other currencies. Changes in exchange rates will therefore affect the value of the investment.
Emerging Markets: Emerging markets are generally more sensitive to economic and political conditions than developed markets. Other factors include greater 'Liquidity Risk', restrictions on investment or transfer of assets and failed/delayed delivery of securities or payments to the Fund.
Gearing Risk: Investment strategies, such as borrowing, used by the Trust can result in even larger losses suffered when the value of the underlying investments fall.
Gold / Mining Funds: Mining shares typically experience above average volatility when compared to other investments. Trends which occur within the general equity market may not be mirrored within mining securities.
