Understanding the stock market

Dorothy Parker, the American writer, once remarked: "Two of the most beautiful words in the English language are `cheque enclosed'." In the latest in our series on the stock market, John Andrew discusses how to make these magic words appear before our eyes on a regular, and generous, basis.

Shareholders are part owners of a company. Should all go well, they will receive a share of their company's profits, known as dividends, usually twice a year. However, companies do not pay out all of their profits to their shareholders.

A proportion is retained to plough back into the business. Technically, undistributed profits are "transferred to reserves" in years when the profits are not as good, so the company can pay dividends from reserves.

When a company prospers, shareholders' rewards are two-fold. In addition to receiving a regular income, they will also hopefully see their shares increase in value.

This is because the profits retained in the business will be put to good use. In turn, this should increase earnings and therefore the value of the business. The result to the shareholder will hopefully be an increasing share price, with dividends rising each year.

This sounds ideal - in theory. However, if you look at The Independent's shares page, you will notice that returns are generally low.

High returns are usually associated with riskier shares. The yield column on the page expresses the last gross annual dividend as a percentage of the current share price. It is the exception rather than the rule to find a gross yield above 5 per cent - most produce less.

Investors who are seeking income from their shares will no doubt be disappointed, as they can generally secure higher returns from simple savings accounts.

Naturally everyone needs a contingency level of savings which provide instant access.

It is also true that higher returns can be obtained from notice or fixed- term accounts. However, maximising short-term returns with savings accounts can be to the detriment of future income.

It is essential for every investor to have a comfort level of savings.

It is equally important for those who will be relying on investment income to consider taking steps to ensure that their income increases over time, even if this means forgoing income in the early years.

This may not be a route that everyone is able, or indeed would wish, to take. It requires planning and professional guidance.

Ideally, in addition to funds in instant access and term accounts, consideration should be given to securing a guaranteed level of income.

This may be achieved by investing in gilts, which are Government securities. These were the subject of this column last month when it was explained that when the current price for a dated gilt is more than pounds 100, it means that the investor will make a loss when the security is redeemed.

Although such gilts pay a high dividend, it must be understood that a proportion of the income paid every year is effectively capital.

When investing for income, the advice is usually that 40 to 50 per cent of a portfolio should be in securities producing a fixed level of income.

If contemplating investing in gilts, professional advice should be sought from a stockbroker or independent financial adviser (IFA).

However, ordinary gilts do not give protection against inflation. An alternative course would be to invest in a fixed interest unit trust.

John Hutton-Attenborough, of IFA Berry Birch & Noble, says it may be worth contemplating the Commercial Union Income Unit Trust which currently yields an income of 7.6 per cent.

This need not be to the detriment of the invested capital. Over the past 12 months, a pounds 1,000 investment would now be worth pounds 1,177 if dividends had been invested. Over five years pounds 1,000 would have risen to pounds 1,780, which is an annual growth rate of 12.2 per cent.

In effect, the fund has grown by a considerable amount more than the amount paid in income over the years.

So as to spread the risk, any shares portfolio should contain at least six holdings spread across different sectors.

In order to absorb the cost of buying and selling the shares, the minimum economic holding per share is around pounds 2,000.

This may not be affordable by more modest investors. However, there is a solution - unit trusts which invest in a mixture of fixed income stocks and shares.

Mr Hutton-Attenborough says the Jupiter Income Unit Trust is well worth considering. With income reinvested, the return over the past year has been 21.6 per cent and an annual equivalent of 27.5 per cent over the past five years.

However, the dividend yield is only 3.7 per cent. This means that pounds 1,000 invested a year ago would have produced an income of just pounds 37.

At the same time, pounds 1,000 invested five years ago would now produce an annual income of pounds 124.51, which is equivalent of 12.45 per cent gross.

This emphasises the fact that that when investing in the stock market for income, one should take a longer-term view and be willing to sacrifice a low initial income for higher dividends later.

Readers contemplating investing in the stock market for income are recommended to seek professional advice.

Independent Partners; Do you need financial advice on your investments, pension or insurance? Book a free consultation with an independent Financial Adviser at VouchedFor.co.uk

Finacial products from our partners
Property search
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

ES Rentals

    iJobs Job Widget
    iJobs Money & Business

    SThree: Trainee Recruitment Consultant

    competitive: SThree: Are you passionate about sales?Do you have a keen interes...

    Recruitment Genius: Loan Adviser - OTE £30,000

    £17000 - £30000 per annum: Recruitment Genius: This is an exciting opportunity...

    Recruitment Genius: Sales Assistant / Buyer

    £15000 - £17000 per annum: Recruitment Genius: This company offers a range of ...

    Recruitment Genius: Customer Service Advisor

    £15000 - £16000 per annum: Recruitment Genius: Customer Service Advisors are r...

    Day In a Page

    Greece says 'No': A night of huge celebrations in Athens as voters decisively back Tsipras and his anti-austerity stance in historic referendum

    Greece referendum

    Greeks say 'No' to austerity and plunge Europe into crisis
    Ten years after the 7/7 terror attacks, is Britain an altered state?

    7/7 bombings anniversary

    Ten years after the terror attacks, is Britain an altered state?
    Beautiful evening dresses are some of the loveliest Donatella has created

    Versace haute couture review

    Beautiful evening dresses are some of the loveliest Donatella has ever created
    No hope and no jobs, so Gaza's young risk their lives, climb the fence and run for it

    No hope and no jobs in Gaza

    So the young risk their lives and run for it
    Fashion apps: Retailers roll together shopping and social networking for mobile customers

    Fashion apps

    Retailers roll together shopping and social networking for mobile customers
    The Greek referendum exposes a gaping hole at the heart of the European Union – its distinct lack of any genuine popular legitimacy

    Gaping hole at the heart of the European Union

    Treatment of Greece has shown up a lack of genuine legitimacy
    Number of young homeless in Britain 'more than three times the official figures'

    'Everything changed when I went to the hostel'

    Number of young homeless people in Britain is 'more than three times the official figures'
    Compton Cricket Club

    Compton Cricket Club

    Portraits of LA cricketers from notorious suburb to be displayed in London
    London now the global money-laundering centre for the drug trade, says crime expert

    Wlecome to London, drug money-laundering centre for the world

    'Mexico is its heart and London is its head'
    The Buddhist temple minutes from Centre Court that helps a winner keep on winning

    The Buddhist temple minutes from Centre Court

    It helps a winner keep on winning
    Is this the future of flying: battery-powered planes made of plastic, and without flight decks?

    Is this the future of flying?

    Battery-powered planes made of plastic, and without flight decks
    Isis are barbarians – but the Caliphate is a dream at the heart of all Muslim traditions

    Isis are barbarians

    but the Caliphate is an ancient Muslim ideal
    The Brink's-Mat curse strikes again: three tons of stolen gold that brought only grief

    Curse of Brink's Mat strikes again

    Death of John 'Goldfinger' Palmer the latest killing related to 1983 heist
    Greece debt crisis: 'The ministers talk to us about miracles' – why Greeks are cynical ahead of the bailout referendum

    'The ministers talk to us about miracles'

    Why Greeks are cynical ahead of the bailout referendum
    Call of the wild: How science is learning to decode the way animals communicate

    Call of the wild

    How science is learning to decode the way animals communicate