Thursday, 7 July 2011

High Yield or Dividend Growth?

As a DIY Income Investor, should you buy a security that yields a flat 6% (such as a commercial bond or preference share) or should you buy a dividend-growth share that yields 3% but with a dividend growing at 7.5% a year?

Jam today or jam tomorrow?

This was one of the questions raised by a thought-provoking article "Dividend Growth vs. High Yield: Some Surprising Findings" on Seeking Alpha.

First consider income on a notional £/$ 10,000 investment, with income reinvested:
  • In year 1 the 6%-yielder yields £/$ 600, in year 2 £/$ 660 (10,600*.06), then £/$ 674, etc. 
  • In year 1, the dividend-growth share yields £/$ 300, in year 2 £/$332 ($10,300*.0323), then £/$369, etc.
It is not until year 13 that the dividend-growth share begins to pull ahead of the fixed-yield investment in terms of income and not until year 19 until the total income earned begins to exceed that of the the fixed-yield investment. Think about that - it will be nearly 20 years before the dividend-growth share will have produced more income than the fixed-return option.

Of course, this comparison would change with different assumptions - and higher yield usually means higher risk (although there are some pretty safe 6% yields available through corporate bonds). You might also argue that total return is important. A fixed interest investment is unlikely to increase in value, while the share price of a dividend-growth share might increase. (However, if the dividend is growing at the same rate as the value of the company you might expect the company share price to remain broadly stable, in an ideal financial world.)

Also, inflation is important - discounting (or the reduction in the real value of future income streams) would tend to favour the current high-yielder over the future high yielder.

However, I think that the basic message for income investors is still similar - jam today probably beats jam tomorrow.

Do you agree?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.


  1. Surely you need a mix? Unless your investment horizon is only 10 years because you expect to die in that time frame, you need a fair lump of jam today but you also need a stake in jam tomorrow to eventually pull ahead as inflation ravages the value of your fixed interest elements over a decade or so.

  2. @ermine
    Yes - and a mix is what I advocate; but this was just a piece to point out that the comparison in yield needs to be considered in your evolving asset allocation.

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