Facing the music over divi cuts

Dipping into capital is taboo – but should you break it?

These are dispiriting days for those needing a decent income from their investments, and for anyone in that situation, tough decisions now loom. Alarmingly, negative interest rates are on the Bank of england’s agenda, making deposit-based savings even less attractive.

At the same time, many companies have cut their dividends either because they have been ordered to by regulators or because of a general view it is wrong to make distributions during the pandemic.

No fewer than 35 FTse 100 firms have cut, cancelled or suspended dividends this year. Payouts could be as much a third down on 2019 at just £60bn.

so with income streams drying up, is now the time to think the previously unthinkable, and dip into your capital?

For many, the notion is anathema. Conventional wisdom is that investors should preserve their capital in order to generate future returns.

BuTwith dividends unlikely to resume their former flow any time soon, increasing numbers of advisers are suggesting it is possible to sell some shares and take profits to maintain the income levels you need – provided you proceed with care.

Rosie Bullard of wealth manager James hambro says the belief that capital is i nviolable is ingrained in the national psyche thanks to the revenues that the landed gentry earned from their estates in centuries past. Ancestral acres were only sold as a desperate measure. ‘The idea that you should never use your capital was still fine in the 1980s, the 1990s and in the early part of this century,’ she says.

‘But the world has changed, particularly for investors who have depended on uK shares, like BP.’

since BP and other formerly generous firms may not reverse their dividends cuts in the near future, Bullard suggests investors should aim for a total return – a mix of income, plus capital growth.

she says: ‘Over the past year, BP has paid a dividend but this was lost in the share price decline, whereas Microsoft gave a total return of 50pc in price growth and dividend.

‘We’re not writing off income generation, but we recommend to clients that they check at the end of the year what income their portfolio has generated.

‘They can then see if they can use some capital gains to supplement. Remember you have a capital gains tax (CGT) allowance of £12,300. Once this is used up, CGT rates are, at least for the moment, lower than income tax rates.’

For some investors, this strategy may involve too much risk. By dipping i nto capital, you are reducing the pot on which you earn your profits and dividends in the future. But re-thinking your approach can still be a way to boost your earnings.

Investment trusts can provide growth and income because they can dig into their reserves.

Murray Income (yield 4.8pc) is one of the 19 trusts that has increased its dividends for more than 20 years. Lately this is thanks to its holdings in Astrazeneca and other pharmaceutical companies.

Other trusts on the dividend heroes l i st compiled by t he Association of Investment Trust Companies i nclude City of London ( yield 5. 9pc) whose holdings include BAe systems and Persimmon.

These groups have recently resumed payouts. Regardless of the controversy, some companies still feel they have a duty to shareholders. As a result, the Footsie should still yield about 3.5pc this year, according to AJ Bell, the investment platform.

however, the 1.4pc aggregate dividend cover (a measure of a company’s ability to afford the dividend) is somewhat thin, casting doubt over companies’ future ability to reward shareholders as the recession bites.

And the most munificent business is tobacco group BAT, which is anathema to some investors.

some trusts aim to appeal to the growing tribe of investors who want an esG (environmental, social or governance) element to their portfolio, plus an income.

James Carthew of analytics group Quoted Data suggests trusts which back housing for the homeless or social housing.

The hOMe trust, which is being launched this month by wealth manager Alvarium will target a total return of 7.5pc by building and funding accommodation for homeless people that is let to charities or housing associations. These bodies receive housing benefit from the Government.

This income may not be guaranteed, but default is unlikely. The same applies to the rental income stream received by the social housing trusts Civitas and Triple Point which both yield close to 5pc.

since you are rethinking your ways of securing the income, you could try to have some fun along the way.

Carthew cites the hipgnosis songs trust (yield 4.3pc) which acquires rights to hits from artists like Blondie, stormzy and Adele.

When you hear Adele’s someone Like You on the radio, they are truly playing your song.