The dividend hero investment trusts yielding more than 5%

 Writer, Laith Khalaf
 Thursday, March 14, 2024

AJ Bell

It’s not just cash savers and bond investors who are enjoying income yields above the rate of inflation, so are those buying investment trusts with exceptionally long records of increasing dividends.

Five UK Equity Income trusts are currently yielding above 5%, together providing an average yield of 5.8%. That compares to the best variable Cash ISA yielding 5.11% and the best fixed term cash ISA yielding 5.25%, according to Moneyfacts.

Of course, unlike cash, capital and income is not guaranteed when holding shares. However these trusts have increased their dividend each year for at least 23 years, through the dotcom crash, the global financial crisis, and the Covid pandemic. City of London investment trust has an unbroken dividend record stretching back to 1966, the year in which England won the football World Cup and number one records in the UK included songs from the Beatles, the Kinks and Elvis Presley.

There’s no guarantee of a rising income going forward, but the resilience shown by these dividend heroes over such a long time should provide investors with some comfort. Investment trusts can hold back income in the bad years to pay out dividends in the good years, a mechanism which has allowed some to continually raise their dividends for decades. This doesn’t increase the overall dividend yield produced by the underlying portfolio of shares, but it does offer investors a smoother ride, something which is especially prized by those relying on their investment portfolio to deliver a retirement income.

	Yield	5-year annual dividend growth	Discount	Years of dividend increase
City of London	5.1%	2.6%	(2.1%)	57
JP Morgan Claverhouse	5.2%	4.6%	(5.4%)	51
Merchants Trust	5.2%	2.2%	(1.2%)	41
Schroder Income Growth	5.2%	3.2%	(10.8%)	28
Abrdn Equity Income	8.4%	3.5%	(8.3%)	23
Average	5.8%	3.2%	(5.5%)	40

Source: Association of Investment Companies, data as at 8 March 2024

An 8% yield tomorrow from investing today

Based on the historic dividend growth achieved by these trusts, after 10 years they could be yielding 8% a year on an investment made today (based on a 5.8% current yield rising by 3.2% per annum). This also makes them an attractive segue for investors approaching retirement and looking to beef up their future income. Until the income taps are turned on investors can reinvest dividends, further bolstering their eventual income when they come to draw on it.

These are of course not the only investment trusts available to investors, and others may offer a more appealing combination of income and growth prospects to some investors. However, these trusts do showcase the high income stream that can be generated by investing in UK stocks, alongside the prospects for a growing income stream too.

The prospect for both dividend and capital growth are key attractions provided by the stock market to income investors. This is in marked contrast to cash where over time the interest generated is dictated by interest rate changes in both directions, and where there is no long run upward trend that can be relied on.

In the near term it looks like cash rates are likely to fall, with the market pricing in three interest rate cuts from the Bank of England this year. Further falls are then anticipated until the base rate reaches a stable level of around 3.25% in two years’ time (source: OBR). So while headline cash rates look appealing right now, those who are saving money for the longer term face a declining return picture in coming years.

The ISA protection for income stocks

As the tax burden rises as a result of frozen income tax thresholds, so does the value of holding income-producing assets in an ISA. The dividend allowance is being cut to £500 from 6 April, and 2.7 million people are forecast by the OBR to be brought into paying higher rate tax over the next five years, with a further 600,000 more taxpayers tipped into the additional rate tax bracket.

The chancellor’s recent National Insurance cuts don’t alter this picture, and nor do they reduce the tax payable on dividends. A higher rate taxpayer investing £20,000 in a portfolio paying 5.8% with dividend growth of 3.2% per annum would save £2,842 over 10 years by using an ISA. A higher rate taxpaying couple using their ISA allowance at the end of this tax year and the beginning of next, so £80,000 in total, would save £14,744.

Dividend tax saving by using an ISA after 10 years
Taxpayer	£20,000 single ISA contribution	£80,000 couple’s ISA contribution across two tax years
Basic rate	£737	£3,822
Higher rate	£2,842	£14,744
Additional rate	£3,314	£17,190

Source: AJ Bell, based on 5.8% portfolio yield with 3.2% annual dividend growth