Why generating a high income from investments just got harder

6 min read 25 Jun 21

Dividend cuts and very low yields on government bonds mean investors may have to recalibrate their expectations for investment income in the coming years.

Among the challenges that faced us all during the last year or so, the income you received from your investments probably did not top the list.

Yet the effects of COVID-19 and the global economic downturn it precipitated have created a hostile environment for income investors.

Indeed, you might have seen the income you receive from your investments go down. The distributions that several M&G funds paid out to their investors fell in 2020 because less income was generated from the underlying investments they hold, such as bonds or company shares.

Unfortunately, as with many other aspects of life, it looks unlikely that things will return to how they were before the pandemic. For those looking to generate a high income from their investments, the outlook is more challenging than at any point for more than a generation. 

Dividend cuts in 2020

Economies ground to a halt amid the coronavirus lockdowns, forcing many companies into challenging positions. Several decided to cut their dividends.

A roster of well-known UK companies suspended or scrapped their payouts to shareholders in early 2020. These dividend cuts particularly affected investors who target regular income from their shareholdings.

By December 2020, the dividend yield on the FTSE All-Share Index of the largest UK-listed shares had fallen to 3.4%, down from 4.3% one year earlier, before stockmarkets slumped. The dividend yield on the S&P 500 Index of the largest US-listed shares also fell over the year, from 1.9% to 1.5%.

Index total returns over 5 years (£)

  2020 2019 2018 2017 2016
FTSE All-Share -9.8% 19.2% -9.5% 13.1% 16.8%
S&P 500 15.5% 28.4% -6.3% 20.3% 10.9%

Source: FTSE Russell/S&P Dow Jones Indices, 11 January 2020

Past performance is not a guide to future performance. Dividend cuts remind us that they are never guaranteed. Company management can choose to reduce or stop distributions at any point, as fortunes dictate.

The long decline in bond yields

Notwithstanding the effects of the pandemic in 2020 and the challenges many businesses are facing, long-term structural forces have depressed the income available on another major asset class: government bonds.

Government bonds issued by the likes of Germany, the UK and the US are often perceived as a ‘safe haven’ in a crisis, because these countries are seen as very unlikely to default on their debts. Their bonds’ yields would be lower than those of others, reflecting higher demand and so a higher price. (Yields, which represent the interest received by bondholders, usually expressed annually as a percentage of the bond’s value, move inversely to prices.)

Over the past 30 years, however, powerful forces have been pulling government bond yields down on top of that. The megatrends of demographics (rising numbers of people buying bonds for retirement income, attracted by the promise of regular interest payments), globalisation and technology (which have helped keep a lid on inflation, and therefore official interest rates low) have each contributed. 

How government bond yields have fallen across developed markets

Source: Bloomberg, 30 November 2020

Past performance is not a guide to future performance.

Since the global financial crisis, central banks have also bought bonds to support their economies by maintaining low rates of interest, as part of a policy called quantitative easing (QE). This bond-buying has pushed prices up and yields down. The pandemic has led to a ramp-up in QE again.

No income will be risk-free

Even before the pandemic, investors seeking to generate a healthy income already had to look beyond very low-yielding mainstream government bonds.

Since then, the yields on many less risky corporate bonds have also fallen, as have dividend yields on many large company shares.

There are pockets of the global market where the prospective income for investors remains attractive. The trade-off, though, is often that the risks of disappointment – and of potential losses – are greater than many investors may be accustomed to.

While we may all have to recalibrate our expectations for investment income in the coming years, this is not to say that our ambitions for investment returns need to be lowered. This is because total returns are the sum of both income and capital growth.

It is entirely possible that rising asset prices may continue to drive investor returns, much as they largely have over the past decade or so. For instance, it has not been large dividends that have propelled recent returns for investors in global technology giants, but their soaring share prices, predicated on widely held expectations of their sustained expansion.

But remember, past performance is not a guide to future performance.

If you are relying on your investment pot to generate a certain income, perhaps if you are in retirement, you might weigh up the merits of drawdown. This is where you choose to regularly sell a small percentage of your assets to create a supplementary income stream.

However, it is a strategy that carries risks, especially if your remaining assets fall in value and your savings end up being eroded too quickly.

Still, at a time when the income paid out from your investments may not be enough for you to realise your ambitions, it could be an option worth discussing with your financial adviser.

The views expressed in this document should not be taken as a recommendation, advice or forecast. We are unable to give financial advice. If you are unsure about the suitability of your investment, speak to your financial adviser.

The value and income from a fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise and you may get back less than you originally invested.

By M&G Investments

The views expressed here should not be taken as a recommendation, advice or forecast.

The value and income from any fund's assets will go down as well as up. This will cause the value of your investment to fall as well as rise. There is no guarantee that any fund will achieve its objective and you may get back less than you originally invested. 

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