Why is income growth so important?
Posted by: Tom Purdie
To take advantage of the potential of the best equity income funds, particularly derived from emerging markets, investors must adjust their mental approach i.e. away from an obsession with day to day moves of the capital value, to a greater focus on the lack of volatility and relative predictability of the income.
Assume fund Z will increase payouts by 5% p.a., and fund X by 10% p.a.
A 60 year old invests in fund Z. The initial income is £10,000 p.a., with 5% growth in the payout, the income grows to almost £20,800.
A 60 year old invests in fund X. By age 75 the initial income of £10,000 p.a. is £41,800 i.e. twice as much, due to 10% p.a. payout growth. This staggering differential desperately needs to be grasped by UK investors.
The problem for UK investors is that they are invested in a large number of UK equity income funds which resemble fund Z. Over the last 10 years the compound annual growth rate for emerging market dividends was 18.2%, and for developed markets was just 7.4%.
ACTION FOR INVESTORS
Investors need to change their mental approach to income investing
Think of the income portfolio like your heart pumping out blood - the heart continually changes shape as it pumps out a steady stream of blood. The capital value of your income portfolio will also vary from day to day, but there will be a steady flow of income, growing income.