High yielding shares and income investing: a UK guide

Most investors, when they picture the stock market, think of price charts going up. That is only half of what owning shares gives you. The other half, and for some people the more valuable half, is the cash that companies quietly pay into your account simply for being a shareholder. That cash is called a dividend. A strategy built around collecting those payments is called income investing, and in the UK it has a long and devoted following.

The concept is straightforward. When a company makes a profit, its board has a choice. It can reinvest the money back into the business, it can buy back its own shares, or it can hand a portion directly to the people who own the company, meaning the shareholders. Most mature UK businesses do a bit of all three, and the portion handed out is your dividend. Some companies pay twice a year, some quarterly, and a handful pay monthly. The amount is decided per share, so if you own a thousand shares in a company paying a final dividend of ten pence each, your payout is a hundred pounds, and it arrives in your brokerage account without you having to lift a finger.

Yield is the number that makes this tangible. If a share costs 500 pence and pays 25 pence a year in dividends, its yield is five per cent. That is simply the annual dividend divided by the share price, expressed as a percentage. You will see it quoted on every broker platform and in every share listing, usually as dividend yield or just yield. The higher the yield, the more income you are getting for every pound invested, at least on the face of it. That last phrase matters, and we will come back to it.

Why do dividends get so much attention from serious investors? Because over long stretches of history they have done a huge amount of the heavy lifting in total returns. Research from the London Business School and others has consistently shown that, for the UK market, reinvested dividends have produced the majority of real returns over the past century. Share price gains get the headlines. Dividends quietly do the compounding. A share that pays you five per cent a year will, if you reinvest the payments and the yield holds, roughly double your money in around fifteen years without the share price moving a penny.

The FTSE 100 is well suited to income investing because it is stuffed with mature, cash generative businesses. Think of the large oil companies, the pharmaceutical giants, the big banks, the tobacco firms, the utilities, the household insurers. These are not racy growth stories. They are slow, established operations that throw off steady cash, and that cash tends to come back to shareholders. Companies like Legal and General, National Grid, Unilever, GSK, Shell and BP have long been favourites of UK income investors, though the quality and reliability of each one varies and changes with the years. The FTSE 100 as a whole has historically yielded between three and five per cent, which is notably higher than the S&P 500 in the United States, where dividend culture is thinner and buybacks are more common.

Here is where we come back to the phrase on the face of it. A high yield is not automatically a good thing. There is a phenomenon called the dividend trap, and every income investor needs to know it. Yield is dividend divided by price. If a share price falls sharply because the market has lost faith in the company, the yield shoots up on paper. A stock that was yielding five per cent can suddenly appear to yield ten or twelve, and that can look like a bargain. What is often happening is that the market is telling you, loudly, that the dividend is about to be cut. When the cut comes, the yield collapses and so does the share price. The investor who chased the headline figure ends up with less income and a capital loss.

Avoiding that trap comes down to asking whether the dividend is genuinely affordable. Two numbers help. Dividend cover is how many times the company’s earnings could pay the dividend, and a figure of roughly two or above is generally considered healthy. Payout ratio is the flipside, the percentage of earnings being paid out, and anything above about seventy per cent starts to look stretched in most industries. You also want to look at the history. A company that has raised its dividend every year for a decade through recessions, interest rate changes and political noise has demonstrated something real. A company paying a flashy yield today, with little track record and a payout ratio near a hundred per cent, is telling you something different.

Where you hold these shares matters as much as which ones you pick. Dividends outside an ISA or pension are taxable once you pass the UK dividend allowance, which has been trimmed repeatedly in recent years and is a shadow of what it used to be. Inside a stocks and shares ISA the dividends are entirely free of tax, forever, and the income can either be drawn down or reinvested automatically through most platforms. For a long term income portfolio the ISA wrapper is close to essential.

Reinvestment is the quiet superpower of this approach. If you take every dividend as cash, you have a steady income stream. Useful. If you instead set your broker to automatically buy more shares with each payment, you end up with more shares paying more dividends, which buy more shares, and so on. That is compounding applied to income. For an investor in their twenties, thirties or forties, reinvesting through an ISA is often a better long term approach than drawing the cash. Closer to or during retirement, income investors frequently flip the switch and start taking the dividends as spending money, letting the capital sit.

Income investing is not right for everyone. If you are looking for big capital gains in a short period, dividend heavy portfolios will usually frustrate you, because the companies paying generously are the ones past their high growth years. If you want a portfolio you can largely leave alone, that pays you for patience, and that behaves a little more calmly in rough markets than a pure growth approach, then high yielding shares, chosen carefully, have a quiet but important place.

TL;DR — the short version

• A dividend is cash a company pays directly to shareholders, and income investing is the strategy of building a portfolio to collect those payments reliably.
• Yield is simply the annual dividend divided by the share price, expressed as a percentage.
• Over long periods, reinvested dividends have produced most of the real returns from UK shares.
• The FTSE 100 is a natural hunting ground for income, with typical yields between three and five per cent.
• A very high yield can be a warning sign that the market expects a dividend cut, known as the dividend trap.
• Dividend cover, payout ratio and a long track record help separate genuinely strong income shares from stretched ones, and an ISA keeps the tax bill off the payments.

Disclaimer: The value of investments can go down as well as up, and you may get back less than you invest. This article is for informational and educational purposes only and does not constitute financial advice. Always do your own research and consider seeking independent advice before making any investment decision.

This article is for informational purposes only and does not constitute financial advice. Investment values can go down as well as up. Always do your own research before making any financial decisions.