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Why dividends are more important than you might think

Kicking off a series exploring the power of dividends, Equity Analyst Emilie Stevens starts with why dividends are more important than you may think.

Important notes

This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

Dividends may not get the heart racing like rapid share price growth. But they’re arguably more important when it comes to how much money you could make from an investment.

Over the next few weeks we'll talk about what we look for in a dividend paying company and how you can find them. We’ll finish with some income ideas for 2020.

But first, here’s why we like dividends.

This article is not personal advice. If you're unsure whether an investment is right for your circumstances, please seek advice.

Dividends - the secret growth sauce

Dividends are often only talked about as a way to provide a regular source of income. But we think the potential power of dividends needs more airtime when it comes to growing the value of your investments.

Income can make a big difference to your investment pot over the long run, especially if you choose to reinvest it.

Here’s an example of two initial £1,000 investments in 2010 both invested in the UK stock market. As you can see they’ve grown to quite different values . One reinvested dividends along the way and has grown to £2,190*. The second took the dividends as cash and is now worth £1,525, having taken home just over £300 as income.

By buying additional shares with the paid dividends the number of shares increased over time and these additional shares would then have paid out further dividends along the way. It can be one of the most powerful ways to grow your investments and increase your income over time, although of course there are no guarantees.

In reality, share prices and the dividends they produce will rise and fall so you could get back less than you invest. Please remember past performance is not a guide to the future and inflation will erode the value of cash over time.

Value of £1,000 invested in the UK stock market 10 years ago

Past performance isn’t a guide to the future. *Source: Lipper IM 31/01/2020

Why we like dividend payers (a few more reasons)

Dividends give us a chance to get something from an investment sooner rather than later. And importantly, they aren’t dependent on the share price rising or what other investors think our shares are worth.

For example, a company could be growing, doing exactly what you bought it for, but news at the time you decide to sell, or differing investors’ beliefs, mean the share price could be below where you think it should be.

Dividends are different. They’re determined by the performance of the company and a way for shareholders to ‘share’ in the profits made that year. Companies pay dividends in different ways. Some will share a fixed percentage of profits with investors each year whilst others might promise to grow the dividend to match or beat inflation. A result of performance not perception means dividends can be a more reliable reward for investors, although they’re not guaranteed.

By getting paid along the way, dividends can make you less sensitive to the ups and downs of the market. You could even benefit from short-term dips, if you choose to re-invest them.

When the share price drops, the same dividend payment could buy more shares at the lower price. So you could build up a larger holding and have the opportunity to benefit if the share price rises, but remember markets could also fall further.

More on dividends – coming soon

Now this might all sound good, but a dividend today isn’t much use if the company can’t afford to keep paying it. That means we look for companies that we think can afford to keep paying a dividend, have the ability to grow payments, and with a long and resilient dividend track record – though past performance isn’t a guide to the future.

Over the next few weeks we’ll look at how to find dividend-paying companies. And our 3 income shares to watch.

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    Important notes

    This article isn’t personal advice. If you’re not sure whether an investment is right for you please seek advice. If you choose to invest the value of your investment will rise and fall, so you could get back less than you put in.

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