Protect your income from dividend cuts

Posted by Adrian Lowcock in Latest insights category on 27 Mar 20


Dividend cuts seem inevitable as many companies look to conserve cash in the short term to protect their business. Whilst this is necessary if they are to survive and pay dividends in the future, the impact on pensions and retirement income is going to be significant.   ITV, Marks & Spencer and InterContinental Hotels are among the firms that have either slashed or cancelled their dividends so far.

We look at five tips to help protect your income from the dividend shock set to come.

Cash buffer

This is the time to use your cash savings. Having a couple of year’s income in cash protects you from the volatility of markets because you do not have to draw down your investments during a sell-off. It means you have time to prepare for any drop in income and smooth out the impact.

Annuities

Annuity rates are currently unattractive for many and given the recent cut in the Bank of England base rate, they are unlikely to get better any time soon. However, if you are a smoker or an older retiree then could be worth considering as you may be entitled to enhanced rates. Annuities offer something that stock markets cannot: a stable income come rain or shine. 

State Pension

Similar to annuities, the state pension is a good support for anyone who has finished working. It is there to ensure everyone has a minimum income from which to live off in retirement.

Diversification

Just as it is important to make sure you hold a diverse range of investments spanning a variety of markets and asset classes, it is imperative that you diversify your income. This means having income from equities to bonds and infrastructure to real assets. Also, it is equally important to diversify within an asset class so if one company cuts its dividend then the impact on the overall income generated by your portfolio is limited so you don’t suffer as much.

Quality

Not all sources of income are equal. In the current climate, with profits under threat, it is difficult to know which dividends are more secure. Some sectors are defensive such as food retailers and utilities, other areas more vulnerable such as airlines or hotels. A high dividend cover is usually a good sign. It shows how much of the dividend is being paid from profits, a cover of 1 means all profits are being used to pay the dividend. Cash on the balance sheet is also worth checking as it means a company can support a dividend if profits dip, for a little while.

Richard Colwell, who runs the Morningstar silver-rated Threadneedle UK Equity Income fund, focuses on quality companies with strong cash generation where dividends are well funded.

For a global approach, Dan Roberts who manages the Fidelity Global Dividend fund, which is Bronze-rated by Morningstar, invests in companies with stable finances and strong cash flow, offering a healthy and sustainable yield that offers a good degree of capital protection during market downturns.

The First State Listed Global Infrastructure fund invests in companies involved in various areas of infrastructure. This asset class tends to be defensive and have reliable income-generating characteristics. Manager Peter Meany likes companies that provide essential services as these can often raise prices in line with inflation without seeing a drop in demand.

For more investment ideas you can check out the Willis Owen Focus 50. A list of ethical, growth, income and passive funds selected by our research team using insights from Morningstar, our research partner.