We politely resist requests for an income producing portfolio and instead advocate investing for total return – capital growth and income. Why?

Well, take Provident Financial plc, for example, a £2.6bn company and the UK’s largest subprime lender. It paid a tasty dividend yield of 7.7% which would have been noticed by most income investors. Was this yield clouding their judgment when shares in Provident Financial plc fell 66% in a day on 22 August?

Analysts had been cutting their forecasts since the spring and the company issued a profits warning in June. Star fund manager Neil Woodford was a big investor and argued the problems were short term. I wonder if the 7.7% yield was clouding his judgement as well?

Lots of investors take comfort in their portfolio producing an income, either so they can spend the income and keep the capital intact or reinvest as they see fit.

The appeal of dividends stems from a belief in them being less risky as they offer a regular income stream. But dividends are not created out of thin air, they come from corporate earnings which are reflected in the share price.

Once a dividend is declared, the share price adjusts to reflect this fact. The capital value of a portfolio is therefore negatively affected unless the dividend is reinvested. Although no shares have been sold if the dividend is spent, the economic impact is the same.

Dividends are far from certain or guaranteed, but the biggest factor in pursuing an income seeking portfolio is much lower diversification as you have excluded about 35-40% of global shares and in a DIY investor favoured UK-only approach would result in overexposure to oil, mining and banking sectors…. three sectors not known for stability!

Most income seeking investors want the cash to cover their cost of living, with such costs recurring every month, yet the dividends an investor earns vary wildly from one month to the next.

Our approach is to invest globally and, where required, set portfolios up to send a fixed amount in pounds and pence to the investor every month. Some months this might require selling a few investments, other times sufficient dividends have accrued and we reinvest the cash.

This gives far greater control over the level and timing of cash flows and the risks in a portfolio, lower reliance on dividends being maintained, increased diversification and often greater tax efficiency.

As I’ve said before, focus on what you can control.

Live long and prosper

Philip Challinor Director