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Should young investors bother with income funds?

22 August 2023

Experts say that dividends can still play a role in a 20-year old’s portfolio, despite their long-term horizon.

By Jean-Baptiste Andrieux,

Reporter, Trustnet

Income funds are rarely considered a feature of younger investors’ investment strategies and much more as the prevail of older individuals needing a steady income in retirement.

As they have a long-term horizon, young investors’ portfolios are usually skewed toward funds targeting higher growth companies that strive to become long-term winners. Those businesses tend to pay little or even no dividend as they have to reinvest their profits in the business to fuel growth. In contrast, income-focused strategies tend to target more stable and mature businesses.

Growing assets is the priority for younger investors, but experts say that income funds can still play a role in their portfolios. To begin with, income investing can be a useful strategy for nearer-term goals such as saving for a house deposit and provide a cushion during market volatility during which high-growth strategies may struggle.

Moreover, Nick Wood, head of fund research at Quilter Cheviot, said that dividends have tended to make up a significant part of total return within most equity markets and capital return a smaller proportion over the long-term.

He added: “It does of course depend on the market environment, and post the financial crisis of 2008, capital return, particularly in the US has been dominant, but we should expect this to revert on the long-term.”

There are, however, a variety of equity income strategies, with some more adapted to younger investors than others. For instance, some funds will focus on higher-yielding assets and attempt to produce an income that matches or beats the index and others that will focus more on dividend growth.

The former will potentially have to give up the potential for greater capital returns over the long-run, while the latter will provide the opposite return profile, with more potential for capital growth as opposed to headline yield.

Kamal Warraich, head of equity fund research at Canaccord Genuity, said: “Income strategies certainly have their place in almost every portfolio, but for teenagers and young adults with a multi-decade timeframe, presumably there should be more focus on maximising one’s total returns.

“This would imply that they need to focus on capital growth and dividend growth strategies, as opposed to those that supply high headline yields (which are generally targeted to investors who need income today).”

This is also the view of Isaac Stell, fund research manager at Parmenion, who said that strategies focusing on capital growth and dividend growth offer the best of both elements. Yet, he called on young investors to seek dividend payers both in their home market but also overseas.

He said: “Young investors should not just seek out dividend payers in their own countries (although the UK leads the way on this) but ensure that their strategy is diversified on a regional and sectoral basis.

“This ensures that market or idiosyncratic risk relating to a particular sub-sector can be fully diversified away. The adage, ‘diversification is the only free lunch in investing’ is true regardless of the investment strategy taken.”

Wood mentioned Japan where companies are paying out an increasing level of dividends as they look to reduce cash on their balance sheets and the wider Asian region where companies pay a growing dividend and have strong balance sheets to continue paying an income.

Yet, Jonathan Griffiths, investment product manager at ebi, sees more merits in a total return approach rather than an income-focused one for younger investors with long investment time horizons and no immediate income requirements.

This is because it enables to invest across a wider range of assets rather than having to focus on the high-yielding ones, reducing the risks associated with lower concentration in certain sectors or factors.

Griffiths said: “For example, an income-focused approach can lead to sector and factor biases, such as an over-exposure to the value factor.”

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