DIY Investor Magazine
| August 2017
44
ETF ACADEMY:
ETFS FOR INCOME
Years of near-zero interest rates have crushed the
income that can be achieved from traditional sources.
ETFs that deliver good dividend yield could be just
the answer for those looking to take advantage of new
pension freedoms and generate income in retirement.
Some investors buy individual shares for income
believing they can cherry pick but studies have shown
most will fail to beat their benchmark.
Buying a large portfolio of blue chip stocks can be
costly due to multiple trading fees and stamp duty
and is not as diversified as an index tracker, and whilst
actively managed income funds deliver diversification,
most will not beat the market and annual management
fees are steep.
Income investment trusts are popular but often trade at
a premium or a discount to the value of their holdings
which means you might pay over the odds to buy into a
trust, or to sell it for less than it’s worth.
ETFS FOR INCOME
A portfolio of well-chosen ETFs that invest in different
categories of income paying shares (or other assets, like
government bonds) may offer the best all-round income
solution.
With just a handful of ETFs, you can build a diverse
income portfolio, with less risk and because fees are
much lower than those of an actively managed fund,
you’ll retain more of your income to reinvest or to spend.
UNDERSTAND YOUR ETF
ETFs divide between those that reinvest income for
capital growth and those that distribute and even among
ETFs targeted at income seekers there are choices, so
it is important to understand the methodology of the
products you select.
Many ETFs pay a dividend income – including many not
specifically aimed at income seekers such as a FTSE
100 or MSCI World ETF.
justETF’s introduction to
and
will help get you started.
DIVIDEND YIELD
Dividend yield is a critical factor in determining an ETF’s
potential for income and relates the income paid out by
an ETF to its share price:
Dividend yield = Annual dividend per share/
cost per share
If an ETF pays 75p as a dividend and it costs
1800p to buy, the yield is 75p/1800p = 4.17%
Dividend yields might refer to the historic yield, based
on the past 12 months, or the current yield, which is
based on a forecast of the next 12 months’dividends - a
good estimate for future distributions is the dividend of
the past 12 months.
As prices fluctuate, the absolute annual distribution
provides information about the consistency of the
dividend. When investing for future income, the current/
forecast yield is a key indicator which can only be a
‘best guess’, rather than the more certain return from
bonds or a fixed-rate cash savings account.
A high dividend yield is not always the best investment,
even for income seekers, if the security of the income
is uncertain, or if it’s too volatile. Remember too that
income is only one component in the potential gains
from shares. A lower yielding ETF might hold companies
that attract investors for reasons other than income, and
so could outperform in total return terms.
Nevertheless, the current dividend yield is a good
starting point for finding interesting ETFs for an income
portfolio and it is usually possible to search for ETFs
with the highest dividend yield.
