How to get a progressive dividend income from your shares

Progressive dividends are the Holy Grail for many investors.  They want steady, reliable dividends paid out from the companies they own because they want a progressive income from their portfolio as a whole. 

But you don’t have to have an obsession with progressive dividend-paying stocks just to get a steady, inflation-beating income from your portfolio.

The problem with focusing completely on progressive dividend-paying stocks is that you limit the number of companies that you can invest in.  You can also sometimes end up overpaying for those companies because there are relatively few of them.

Another problem with obsessing over progressive dividends is that it often leads investors to rush for the exit if a dividend ever does get cut.  I think that’s usually a mistake that can lock in huge capital losses rather than accepting a small, often temporary dividend cut.

Instead of focusing completely on progressive dividends, it can make sense to occasionally invest in companies where the dividend isn’t necessarily growing every year or where perhaps there was even a cut or two in recent years.  This can widen out the range of options enormously, and it often means you can get far higher yields for your money too.

Fortunately, it’s relatively easy to get a progressive, inflation-beating income from a portfolio of dividend-paying stocks, even if not every single one of them has a progressively increasing dividend.

Start with a cash buffer

The first step is to make sure the portfolio has a cash buffer.  This will allow you to create a smooth and progressive income from your stocks, even if the incoming dividends are less than perfectly smooth.

There are no hard and fast rules on this, but I think a buffer around the size of one year’s income should be sufficient.  So if you’re looking to draw 4% from your portfolio each year, then a 4% buffer might be a good place to start.

At just 4% or so, this buffer is unlikely to be a huge drag on performance, even though it is sitting in cash earning virtually nothing.  If you’re really allergic to low yields, then you could store the cash in anything that has good liquidity and a fixed capital value (like short-term savings bonds, for example).

Be conservative with how much you draw

Unless you want to start eating into your buffer immediately, or worse, your capital, you may want to limit your initial drawings to no more than the dividends you got last year.

If your stocks do badly next year and your dividend income falls, you could dip into the cash buffer to make up the difference.  With the buffer set at one year’s income, it should easily be able to cover any temporary shortfall.

If you get more dividends next year than you were expecting, you can let the buffer build up as protection against any future downturns.

Be progressive and beat inflation

If you have a portfolio of quality dividend stocks, then the odds are that next year’s dividends will beat this year’s.  This will usually be the case even though you’ve drawn down this year’s dividends rather than reinvesting them.

This means that in most years, you should be able to increase your income by at least the rate of inflation.

If your dividend income is good this year, then you may decide to give yourself a bumper pay rise, but make sure it’s sustainable; otherwise, your progressive income won’t be so progressive.

If dividend inflows are weak, then you could make up the difference from the cash buffer and perhaps increase the payout by slightly less.

But over the long run, I would expect a well-run portfolio to easily produce a steady, inflation-beating income essentially forever.

A progressive income model portfolio

Since March 2011, I have been running a defensive value investing model portfolio.  That portfolio is managed using a dividend reinvestment policy in order to show total returns over time, so it’s focused on capital growth rather than income.  However, I know that many investors, myself included, are also interested in drawing a perpetual, inflation-beating income from their shares.

To illustrate how shares can produce a steady and progressive income, I’ve created an income version of the existing “growth” portfolio.  In order to have something sensible to compare it to, I’ve also created an income benchmark based on a FTSE All-Share tracker trust.  You can see the results since March 2011 below:

Income portfolio performance 2013 10

The holdings of the income portfolio are exactly the same and have been bought and sold at the same prices as the growth portfolio.  There are slight differences in the number of shares bought because the growth portfolio is growing faster because of the reinvested dividends.

I have made the buy and sell dates and prices the same as the growth portfolio so that they are exactly as they would have been if I had managed the portfolio in real-time from 2011 (because they match the growth portfolio’s trades, which were done in real-time).

The goals of this income portfolio are:

  • To have a higher pay-out yield than the FTSE All-Share benchmark (focusing on the amount actually paid out rather than the dividends received from the constituent companies)
  • To pay out a higher absolute amount than the benchmark every year
  • To grow the income faster than the benchmark and inflation
  • To grow the capital value faster than the benchmark in the long term
  • To have less capital volatility than the benchmark

Only time will tell how achievable those goals are, but I’m looking forward to managing this income portfolio alongside the existing growth model portfolio.  I hope it shows how the occasionally wild and manic stock market can still be used to produce a reliable, progressive and inflation-beating income.

Author: John Kingham

I cover both the theory and practice of investing in high-quality UK dividend stocks for long-term income and growth.

2 thoughts on “How to get a progressive dividend income from your shares”

  1. John

    You stepped into my job and want to become a financial planner! By the way, you are welcome, there are other advisers with less knowledge then you.

    I don’t think there are too many retirees with an 100% equity portfolio. There is some research done by Ibbotson (now part of Morningstar) on withdrawal rates with a view to optimise the asset allocation for a retiree. Their results are that the equity component should be between 40% – 60%.

    As financial planners we don’t think in terms of income and capital, but in terms of total return. I do have an old lady as client who doesn’t want to draw more than the income produced by her portfolio, even if at 84 years old, her life expectancy is less than 10 years. Old habits die hard. Unfortunately in her look for income she bought some bank shares in 2006 and her portfolio including her income is around 70% of what used to be. Thanks to Fred – the shred.

    I am a fan of asset dedication in retirement and matching liabilities. This help the retiree to not get caught in ‘reverse Pound cost averaging’ and ‘sequence of investment returns risk’. Using index linked gilts with duration that matches the liability is helpful.

    1. Hi Eugen,

      I’m not too sure I want to become a financial planner! Also, I realise that there are a million and one ways to generate income in retirement, but in the context of this site I have a 100% equity focus and personally expect to be 100% in equities in retirement (as long as my brain can keep up with it).

      What I’m really trying to show here is that progressive dividends are not an absolute requirement for a progressive equity income. There are many investment trusts that use this strategy and they’re popular because they produce a progressive income which negates some of the fears, and takes some of the focus off of, capital volatility.

Comments are closed.