The power of INCOME
At a time when base rates are stuck resolutely at 0.5% and the rates offered by high street banks can be as little as 0.1%, the yield on the AIC Global Growth Sector of 2%* looks appealing, not to mention the yield on the AIC Global Growth and Income sector at 4.2%*. There are a number of reasons why making this kind of comparison between yield and interest rates is not completely fair. Investors have to be aware that their capital is at risk when investing in investment trusts, whereas it is largely protected when deposited at the bank. They also need to bear in mind that inflation will reduce the purchasing power of their income, while yields are calculated relative to a share price which they might expect to rise over time. In addition, the ever-present risk that the capital value might fall has been amply illustrated by the gyrations of the markets this summer, which saw the FTSE 100 lose over 14% of its value.
In times such as these, the importance of
income only increases, whether it is to offset
the increase in the cost of living today, or
to enhance the capital value of a portfolio for
tomorrow.In terms of the cost of living, the Alliance Trust‘s Economic Research Centre’s ongoing study of Inflation and Age would suggest that nobody suffers the rate of inflation reported in the headline number and that it has often been elderly households which have faced the highest rate of inflation. Simply, this means that elderly households have suffered a larger loss of purchasing power than the average household.
Over the last nine years, a household headed by someone aged 75 and over, has suffered a 34% loss in its purchasing power, while RPI would imply an average loss of 25%. For example, in 2003, a 75 year old, with an annual income of £20,000 which had tracked RPI over the previous 9 years, could expect an income of £25,000. However, their outgoings would have risen to £26,800, or a shortfall of £1,800. Although each age group suffers slightly different levels of inflation, none appear to be able to match the stated figure.
Enhancing the capital value of the portfolio is a significant consideration for Alliance Trust. When we buy shares, we look at the dividend policy of the companies in which we invest, considering it a demonstration that the management is committed to its shareholders. To us, it is equivalent to the rent payable on investors’ capital, and we apply that maxim in our approach to the dividends we pay to our own shareholders. Over the last 44 years, we are proud to have increased the dividend we have paid out in each and every year. Amongst our peers, only City of London Investment Trust has a longer unbroken record of dividend increases.
Investment trusts are ideally suited as vehicles for long-term investors; the benefits of this continuity can be seen in terms of both the dividends paid and reinvestment of those dividends in more shares in the trust. Over time, the proportion of the total return derived from dividend reinvestment, will grow to prominence.
Despite the fact that the dividend yield on Alliance Trust is around 2.6% (source FTSE), the income component can become a major part of the total return provided to shareholders. As with any investment, those who opt to reinvest their dividends in additional shares are rewarded through the compounding effect of the reinvestment providing them with a significant uplift over the long term.
In the log chart above, the orange line represents the increase in the value of £100 invested in Alliance Trust in 1890. By January 2011, it would be worth over £87,000. Even allowing for the impact of inflation (the green line) it’s a decent return on the money invested. The blue line, however, represents the value of that same £100 if all dividends received were reinvested. The £100 would now be worth over £13.2m, representing an annualised return of over 10%, compared to almost 6% for the increase in the underlying share price. The size of the difference may seem extraordinary, particularly as the difference in the rate of growth is approximately 4.9%, but it’s the best proof of the advantages of long-term investing.
While 120 years is longer than most peoples’ investment horizon, the figures over 40 years are equally compelling – £100 invested in Alliance Trust in 1969 would, at 31 July 2011, be worth over £2,100. But, by reinvesting the dividend, the holding would be worth almost £6,800. This represents a compound return of 7.8% on the capital and almost 11% when dividends have been reinvested, and the gap can only widen. The compound growth of inflation over the same period is around 3%, although our research would suggest that this probably understates the actual position.
* Source J.P. Morgan Cazenove 19 August 2011
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