Dividend vs growth investing strategies in 2020

Dividend income investing to enable early retirement has been accepted as a core strategy to enable financial independence (FIRE). However, with the present economic turmoil due to the Coronavirus pandemic, perhaps it is time to reconsider going forward the risks involved in dividend vs growth investing.

In the U.K major businesses have cut or deferred £30 billion in dividends to shareholders to enable them to improve their balance sheets and weather the economic shock of Coronavirus. Virtually half of the FTSE 100 companies have either cut, reduced, suspended or deferred their dividend payments according to research by A.J.Bell. Further cuts may continue due to the U.K government imposing restrictions banning firms from using its loan schemes to distribute dividends to shareholders.

Big names such as Royal Dutch Shell, the biggest dividend payer on the FTSE, made its first cut since 1945, reducing its payout by two thirds. Also, the traditionally income reliable banking sector including HSBC, RBS, Barclays, Lloyds and standard Chartered announced in March this year that they would be cutting almost £8 billion in payouts.

Research by A.J.Bell discovered that 50% of retail investors have been affected by dividend cuts loosing on average 27% income. A further 20% had their income reduced by 50% or more. On a more positive note, they also found that 140 U.K companies will be retaining their dividends including 26 on the FTSE 100 such as GlaxoSmithKline, BP, L&G, Tesco and Diageo.

Overall payouts on the FTSE 100 fell by 45% year-on-year, and 76% on the FTSE 250. During the current crisis approximately 3/4 of U.K companies that usually pay a dividend have either cut or reduced them compared to 2/5 during the 2008 financial crisis. 2020 has been without question the biggest hit to dividends in generations.

dividend vs growth investing

What are the current and future implications?

The major fall in dividend income that has occurred and is potentially ongoing, could have a profound effect in several circumstances. If you are at the point of early retirement now and relying on a dividend income to fund your lifestyle, you could be at peril of having to cancel that because your investment income may not be sufficient to match your expenses with the current fall in payouts.

If the poor economic conditions and Coronavirus persist, low payouts could be an ongoing issue for some time. This means that based upon your prior assumptions, you may now no longer be able to afford to retire as early as you thought. Similarly, for younger income investors it may take much longer to acquire FIRE based upon an income reinvestment strategy, as the fall in dividend income will mean that compounding will less effective and your retirement pot will take much longer to grow.

Dividend vs growth investing – your options

A dividend investing strategy can be used in three different ways. Either, you can solely practice dividend investing during your accumulation and retirement phase or utilise growth investing for accumulation and switch to dividend income once retired. You can also use a blend of the two. The current annual dividend yield of the FTSE 100 is 4.81%, the FTSE All-share is 4.66% and the S+P 500 fluctuates but averages around 2%.

Dividend

It now appears clearer that solely relying on a dividend income strategy may carry significantly more risk moving forward than it did before the Coronavirus crisis arose. There is still income to be found but it is not going to be as high or reliable as before. Index income investing could be a more prudent path to achieve income, through lowering costs and risk through diversification compared to investing in an individual stock portfolio.

Dividend investing has always been very popular as many people see it as ‘free money’ but income investing is not without risk. Solely judging a stock by its high yield holds dangers as businesses can often use this to hide more systemic issues within the company. Searching out high quality companies with strong balance sheets and a history of increasing their dividends is a sounder strategy and that recommended by Warren Buffett and others.

A benefit of dividend vs growth investing is that it can provide an income during bear markets when both income and growth stocks will suffer. This could be used as regular income, reinvested, or used to purchase growth stocks at low valuations. Dividend stocks can of course also experience growth resulting in additional investment returns but in general they are not ‘high-growth’. Research on the returns of dividend vs growth investments appears mixed with benefits to both methods.

Growth

Growth investing can lead to significant outperformance compared to dividends particularly in the short to mid term. The Dot Com bubble of the 1990’s is a classic example of this, and also the recent rise of tech stocks and Tesla in particular, during the current pandemic. Dividend stocks can’t really match growth stocks in terms of return when they are in a strong bull market.

Growth stocks can potentially be more volatile than income stocks as they can be subject to strong price dips when they become wildly overvalued. Some ‘growth’ stocks can still pay a dividend potentially, but in general they tend to be companies that invest their profits in R&D, expansion and M&A.

Although many stocks are still at lows following the market crash in the spring, the S+P 500 and the NASDAQ are at all time highs. With extensive global money printing taking place, particularly in the U.S, inflation could start to have an impact. This may result in investors seeking inflation-beating returns which could continue to power the stock markets rise.

Blended strategy

By integrating both dividend and growth investing strategies you can harness the strength of each style and increase your risk management by being more diversified. How you do this will be a personal decision based upon your convictions, style, and attitude to risk. You could for example use a 80/20, 60/40 or 50/50 split similar to a stocks to bonds ratio to allocate the two styles to your portfolio, or whatever percentage you are comfortable with.

Conclusion

It cannot be denied that since the advent of Coronavirus the global economic landscape has profoundly changed. Although some indexes are at record highs, many stocks are at major lows and with mass unemployment and weak business and consumer demand in many areas the outlook going forward is very uncertain – potentially for a long period of time.

The debate over the benefits of dividend vs growth investing will continue but I think now is the time to be more cautious in your investing approach to manage risk more effectively and maintain a positive outcome. I would suggest that a blended strategy of both growth and dividend stocks in a low cost index fund is one of the best ways to achieve this.

source source source source

2 Comments

  1. Thank you for the interesting and well-reasoned material. As I understand it, you have come to the conclusion that it is worth investing in growth stocks, along with investments in index dividend funds? After the collapse in March, I came to somewhat different conclusions. Growth stocks are still at their best, only due to the fact that most of them are high technology. Today there are high risks for this sector … Therefore, it seems to me, it is better to invest up to 70% in indices, which in any case will grow over time, and 30% in dividend companies, which remained at their best even during the crisis. For example, PEP, KO, MCD and many others.

    and forgive me for my bad english ))))

    • Hi lllia,

      I just put my thoughts out there. I believe there is more risk going forward for a dividend only approach for the reasons I have outlined, at least until the Coronavirus Pandemic is past us and the economic climate is more settled and predictable. A way to manage risk more effectively is to be more diversified which will limit your risk to the downside as anything can happen in the markets. A dividend index fund will achieve this more effectively than just holding say 10-20 dividend stocks and is very low cost which helps people with smaller funds.
      Although the growth in indexes like the Nasdaq and S&P 500 has been driven mainly by tech stocks, there are many stocks that are still at low valuations although I do believe Tesla for example is very overvalued. Although we don’t have a crystal ball, the likelihood is that the economy will gradually improve as lockdowns are relaxed and that either virus immunity or a vaccine will be achieved which result in a return to more ‘normal’ conditions where these stocks will gain as companies regain sales and profitability. Much of this growth in Indexes has been driven by money printing and with interest rates at historical lows and the outlook that they will remain there for a long time suggests that investors will still be ‘risk on’ on the stockmarket to try to achieve a decent return. There also appears to be some evidence that some of this move has been driven by smaller millennial retail traders buying via apps like Robinhood etc.
      Its a personal decision for each investor how they construct their own portfolio according to age, risk level and timeline. A smaller focused individual stock portfolio can outperform an index if the stocks within it do well, but equally can do worse if they don’t due to lack of diversification. That is the trade-off of holding an index. It will protect you more in the event of loss but the upside may be more restricted compared to individual stocks. This of course is only if people can pick the right stocks which is difficult to do.
      Holding both growth and dividend in your portfolio will give you the advantages of both and in indexes will give you the best risk management. 70/30 seems a reasonable mix but investors can construct it with whatever balance they prefer. I mainly hold indexes but have an allocation to individual stocks also.

Leave a Reply