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Are you exploring how to generate a side income from your investments? With many people – including UK expats – increasingly interested in “passive income” (money you do not have to work for actively), dividends come under the spotlight.
Can you use dividends to generate a passive income in 2024-25? How do they work, and what is their role within a wider investment strategy? Below, our expat financial advisers at Scottsdale offer some reflections as you consider your own portfolio.
We hope this information is useful. Get in touch to discuss your financial plan with us via a free, no-obligation consultation.
What are dividends?
A “dividend” can be defined as a share of corporate profits. For instance, suppose you own a company with a partner (50:50 ownership split).
If the business makes £100,000 in profit (after tax) and you decide to distribute it between the partners, each person would receive £50,000 in dividends.
You do not have to own a company directly to receive dividends. Another option is to participate in the stock market – i.e. buy shares in companies or funds, which then disperse profits to their investors at various intervals (e.g. quarterly or bi-yearly).
The importance of “yields”
Investors naturally want an idea of how much return they will get on an investment. How does this work when evaluating dividend-paying companies or funds?
Here, an important metric to consider is the dividend “yield”. This involves taking the dividend and dividing it by the price per share.
For instance, suppose two companies pay a £1 dividend per share. The first is valued at £30 per share; the second is £20 per share. This leads to a yield of 3.3% for the former and 5% for the latter.
At first glance, the second company may appear to be a better investment due to the higher yield. However, what is driving the share price?
Investors may be more attracted to a healthy company/fund. This drives up the share price and lowers the yield. By contrast, a failing company may find its share price falling, even as it keeps its dividend the same. This troubled business would have a rising yield.
This is not to say that high yields are always a sign of a company in trouble. Rather, investors need to check the underlying health of prospective investments.
For example, you do not want to invest in a high-yield stock only for it to reduce or cancel its dividend later (e.g. due to lower profits).
Benefits & drawbacks of dividend investing
Dividends can be attractive for retirees and income-focused investors. They offer a source of passive income, providing a useful source of funds alongside others (e.g. salary).
It can feel exciting and empowering to feel a sense of ownership over multiple companies and receive a share of their profits. Dividend-paying stocks also tend to be less volatile, offering much-needed stability during market downturns.
Dividend-paying stocks and funds can also offer long-term growth potential, particularly if profits are automatically re-invested. This allows them to benefit from the power of compounding.
However, dividend-paying companies may offer less growth potential than “growth stocks” (or funds) that pay little/no dividends. These are often more expensive and volatile than dividend stocks, but their growth rate could be faster than the market average.
There is also the risk that companies reduce or eliminate dividends if they fall on hard times. Investors can mitigate this by diversifying their holdings across multiple companies and funds. If one company cuts its dividend, the others can help preserve the investor’s income.
Investors (especially expats) must also be mindful of the tax treatment of dividends in different jurisdictions. For instance, if you receive income (e.g. dividends) from US shares as someone who is non-resident or a non-citizen, a withholding tax may apply. However, this may not apply to certain investors – e.g. those residing in a jurisdiction with a tax treaty with the US.
Final thoughts
The role of dividends in your investment strategy depends heavily on your financial goals, strategy and circumstances.
For instance, a young expat investor may be primarily interested in growing their wealth over the coming decades. Here, dividend-paying investments may be less of a priority if these offer lower growth potential than other assets.
By contrast, someone nearing retirement may be looking to “de-risk” their portfolio as they look to start drawing an income from their portfolio. In this case, dividend-paying investments may be more attractive than volatile growth-oriented shares.
If you want to ensure you’re taking the right steps to safeguard your financial future, please get in touch to speak with an expat financial adviser here at Scottsdale.