You do not need to take big risks to increase your Snowball if you do some basic research to improve your knowledge.
You knew that CTY was a dividend hero, having paid an increased or level dividend for around 50 years.
You watched it fall and waited until it started to go back up and you bought at 322p, the plan being to re-invest the dividend.
You are well on the way of achieving the holy grail of investing, where you take out your stake and earn a dividend on a Trust that cost you nothing, zilch,zero.
You then buy another Trust and try do it all over again. GRS.
The buying yield was around 6%, the current yield 4.75%.
Kyle Caldwell constructs a hypothetical portfolio of funds aiming to achieve £10,000 of income this year.
4th February 2025
by Kyle Caldwell from interactive investor
A year ago, I selected 12 funds with the aim of achieving £10,000 of annual income in 2024.
Collectively the hypothetical portfolio yielded 4.55%, meaning that a sum of £230,000 was required to attempt to hit the target.
While income is the priority, I’m also keen to try and strike the right balance from a total return perspective.
The income target was achieved, with £10,152 of income generated. Overall, when combining both capital and income returns, the portfolio increased to £252,924, which works out as a percentage total return (with dividends reinvested) of 10%.
Before revealing the line-up for the £10,000 income challenge in 2025, let’s look at how last year’s constituents fared.
How the 2024 portfolio fared
Seven of the 12 funds delivered total returns above 10% in 2024.
The mixed-asset fund, Artemis Monthly Distribution, delivered the highest return of 15.7%. This fund typically holds 60% in shares and 40% in bonds. Throughout 2024, its equity exposure had the greatest influence in terms of overall returns. However, various bond holdings also benefited from interest-rate cuts, which cause bond prices to rise and yields to fall.
Artemis Income generated a 15.1% return. This fund aims to provide a steady and growing income along with capital growth. Among the biggest contributors to returns in 2024 were 3i Group Ord
III
and Wolters Kluwer NV
WKL
as well as more “value-oriented” names such as the UK domestic banks and Imperial Brands IMB0.04%.
Guinness Asian Equity Income was third in terms of the highest returns, up 14.9%. Performance was led by banks, insurers and technology companies, specifically those related to the artificial intelligence (AI) theme.
The other funds in the double-digit returns’ club were Fidelity Global Dividend (up 13.5%); Vanguard FTSE UK Equity Income Index (up 12.6%); Man Income (up 11.8%) and Vanguard FTSE AllWld HiDivYld ETF USDAcc GBP
VHYG
(up 11.4%).
At the other end of the table, Jupiter Strategic Bond posted a small loss (-0.2%). In a recent video interview with interactive investor, co-manager Harry Richards said its “long duration positioning” to government bonds – those with long lifespans – had been “a drag on performance”.
The two other holdings involving bonds had a solid year, with total return gains of 5.3% and 9.7% respectively for Royal London Short Term Money Market and Royal London Global Bond Opportunities.
Finally, towards the bottom of the table, with gains of 3.8% each, were Janus Henderson UK Responsible Income and FTF ClearBridge Global Infrastructure Income.
Group/InvestmentStarting value (£)Total return (GBP)Value at end (£)12-month yield (31/12/2024)Estimated Income (£)01/01/2024 to 31/12/2024UK Equity IncomeArtemis Income £11,50015.11%£13,2383.65%£419.75Vanguard FTSE UK Equity Income £23,00012.63%£25,9055.07%£1,166.10Man Income £11,50011.77%£12,8545.17%£594.55Janus Henderson UK Responsible Income £23,0003.82%£23,8794.04%£929.20Global/Overseas Income Fidelity Global Dividend £23,00013.51%£26,1072.65%£609.50Vanguard FTSE All World High Dividend Yield ETF £23,00011.35%£25,6113.08%£708.40Guinness Asian Equity Income £11,50014.86%£13,2093.68%£423.20Mixed Asset Artemis Monthly Distribution £34,50015.69%£39,9134.26%£1,469.70Bonds Jupiter Strategic Bond £23,000-0.24%£22,9455.67%£1,304.10Royal London Global Bond Opportunities £23,0009.67%£25,2245.80%£1,334.00Royal London Short Term Money Market £11,5005.28%£12,1075.65%£649.75SpecialistFTF ClearBridge Global Infrastructure Income £11,5003.77%£11,9344.73%£543.95Total £230,0009.97%£252,9244.41%£10,152.20
Source: Morningstar. Total return figures are one year to 31 December 2024. 12-month yield as at 31 December, used to estimate income from initial value. Past performance is not a guide to future performance.
Purpose of the portfolio
The hypothetical portfolio aims to show DIY investors how they can build their own diversified income portfolios alongside wider research.
The funds are chosen on the basis that over the medium to long term they would be expected to grow both capital and income. However, there are no guarantees these aims will be achieved.
Moreover, it’s important to be mindful of the fact that overall total returns (capital and income combined) can decline, especially in the short term.
Bear in mind that funds must distribute all the income generated each year by the fund. Therefore, when income dries up, as it did in 2020 when the Covid-19 pandemic emerged, a dividend cut is pretty much inevitable.
Investment trusts, on the other hand, can hold back up to 15% of dividends received each year, which means they can build up a reserve to bolster payouts in leaner years.
The line-up for the 2025 portfolio
As I’ve picked each fund for the medium to long term, I’m inclined to avoid making changes each year. However, there are certain things I consider, for example, fund manager changes, short- and long-term performance, and whether I can simplify the portfolio.
For 2025, I’ve decided to reduce the number of holdings from 12 to 10.
The two that stood out to me to eliminate were Janus Henderson UK Responsible Income and FTF ClearBridge Global Infrastructure Income.
Janus Henderson UK Responsible Income is one of interactive investor’s ACE 40 funds, which is a filtered selection from the sustainable investment universe. It’s been managed by Andrew Jones since the start of 2012. Returns have been strong during his tenure (up 206% vs 151% for the sector average),but over one, three and five years, it has underperformed the average UK equity income fund.
In a recent commentary piece issued by the fund, it was noted that the expectation is for domestic stocks to perform better in 2025. This, of course, may well play out. But there’s also the risk of economic growth being lacklustre, with the prospect of inflation surprising on the upside.
The fund, which has a blend of internationally exposed companies and domestic stocks, could profit from a recovery in domestic stocks in 2025, but, for this portfolio, I would sooner focus on the two other active funds I have higher conviction in; Artemis Income and Man Income.
The other change I’ve made is removing FTF ClearBridge Global Infrastructure Income. It made a small loss of -2.6% in 2023, and a small gain of 3.8% in 2024.
The exposure to infrastructure provides additional diversification in the portfolio, which has been one of the reasons for choosing this fund, which is one of interactive investor’s Super 60 investment ideas. On the whole, infrastructure has predictable cash flows (many of which are linked to inflation), giving the considerable defensive qualities of the asset class. However, listed infrastructure is an equity. Therefore, it’s correlated to the ups and downs of stock markets.
The main reason for removing the fund, though, is down to the eye-catching yields on bonds and the prospective price returns for bonds (when interest rates are cut). I would sooner seek out greater bond exposure, particularly given that yields of around 4.5% to 5% can be obtained on the lowest-risk areas of the bond market, such as gilts and money market funds. When interest rates were low, which made bonds less appealing, there was more incentive to invest in alternative income assets, such as infrastructure.
Portfolio weightings
The 2025 portfolio requires £235,000 for the £10,000 income challenge (a portfolio yield of 4.26%). All yield figures were sourced in late January, but bear in mind that yield figures are not static.
For 2025, I’ve increased the bond exposure from around 30% to close to 40%. As my colleague Sam Benstead says, now is a great time to consider bonds, due to the high level of income on offer and the prospect of interest rate cuts, which will boost bond prices. Even if there are fewer rate cuts than expected, the income level that bonds are generating acts as a buffer and can still generate a positive return for investors.
The bond exposure is derived from Artemis Monthly Distribution (which owns 60% in shares and 40% in bonds), Jupiter Strategic Bond, Royal London Global Bond Opportunities and Royal London Short Term Money Market.
While Jupiter Strategic Bond made a small loss in 2024, I like its flexible approach and ability to invest anywhere across the bond market. In the event of interest rate cuts, its long-duration bond positions (which hurt performance in 2024) should pay off. Its fund managers think the market is under-pricing the amount of rate cuts in 2025 and that inflation has become less of a problem. Time will tell.
Royal London Global Bond Opportunities invests in under-researched parts of the market, including unrated bonds. It’s been a solid performer across multiple time periods.
Royal London Short Term Money Market owns a diversified basket of safe bonds that are due to mature soon, normally within just a couple of months, meaning that investors can earn an income on their cash with minimal risk. It has an excellent long-term track record, low drawdowns and is competitively priced with a yearly ongoing charge of 0.10%.
For equities, some exposure comes through Artemis Monthly Distribution, with the rest split 25% each between UK equity income and global/overseas income funds.
The UK choices are Artemis Income, Vanguard FTSE UK Equity Income and Man Income.
Artemis Income is not wedded to one investment style, such as value or growth. It has around 50 holdings. In a video interview with interactive investor, co-manager Nick Shenton said the focus was on “free cash flow first, dividends second”.
Vanguard FTSE UK Equity Income, a tracker fund, physically invests in the constituents of the FTSE UK Equity Income index, which consists of shares “that are expected to pay dividends that are generally higher than average”. Therefore, performance and income generation is heavily influenced by the largest companies in the FTSE 100 index that pay high income.
Man GLG Income undertakes a value-driven approach to provide a yield well in excess of the FTSE-All Share. Henry Dixon has managed the fund since inception in November 2013, when he joined Man GLG.
For global/overseas income, I’ve stuck to the same three funds as last year: Fidelity Global Dividend, Vanguard FTSE All World High Dividend Yield ETF, and Guinness Asian Equity Income.
Fidelity Global Dividend has a low yield of 2.4%. However, its role in the portfolio is to provide a greater balance of returns, as the fund aims to generate both income and growth, while limiting downside risks. Fund manager Daniel Roberts has been at the helm since launch in January 2012.
Vanguard FTSE All World High Dividend Yield ETF, a tracker fund, follows the ups and downs of the FTSE All-World High Yield Index, which comprises more than 2,000 large and mid-cap stocks with higher-than-average dividend yields. It has exposure to stocks listed in developed and emerging markets.
Finally, there’s Guinness Asian Equity Income. This fund’s equally weighted approach of 36 stocks helps to reduce stock-specific risk. Edmund Harriss, who oversees Guinness Asian Equity Income, says the focus is on “companies [with] sustainable competitive advantages, that are making things or providing services that people want to buy, and doing it better than their peers”. Harriss has managed the fund since inception in 2006.
The main reason I invest is to build my second income. Further down the line when I’m thinking about retirement, I want to have a stream of income that I can rely on to help me enjoy life more. That’s the dream, isn’t it?
How to invest
Before I started to think about how much I wanted to invest, the first step I’d take would be to open a Stocks and Shares ISA. That’s because I wouldn’t be taxed on any profit I made. From the dividend shares I’d be buying, I’d also be able to keep all of the passive income I received from dividend payments.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Starting out
So, I’ve decided I’m going to invest with my ISA. That’s the best way for me to set myself up for success. But what’s next? Well, now comes the most important part. It’s about getting started no matter how much money I have to invest.
But that’s far from the case. How we start doesn’t matter. What’s imperative is that we start as early as possible and over the long run let the stock market work its magic. I think £100 a week is a sensible starting amount.
Phoenix Group Holdings
Let me show an example of just how powerful this can be. The stock I’m going to use is Phoenix Group Holdings (LSE: PHNX). It’s an insurance company and a leader in the sector.
Its share price is down 1.8% so far this year. But a falling share price isn’t always a negative. For savvy investors, it means they can snap up bargains while the rest of the market overlooks it.
At its current share price, it has a dividend yield of 10.1%, way above the FTSE 100 average (3.6%). I like Phoenix Holdings because it has a strong balance sheet with plenty of cash spare as well as a rising dividend payout.
Money to be made
Taking my £100 a week and applying it to Phoenix Group’s 10.1% yield ought to see me make slightly over £525 a year in passive income. Not bad.
However, the longer I leave my money in the market, the better chance I have of building my wealth. If I adopt a 30-year investment timeframe and reinvest all the dividend payments I receive, at the end of that I’d be making £10,168 a year in second income. I’d have a nest egg worth £106,269.
Investing always comes with risks and the stock market is volatile. There’s no guarantee that Phoenix Group’s yield will stay the same. It could rise or fall. Nevertheless, what this shows is that even investors starting from scratch are able to build a sizeable pot if they give it time.
Perfect funds to hold alongside your global tracker
04 February 2025
By Patrick Sanders
Global trackers have become extremely popular with investors. In theory, they should bring diversification to a portfolio, ensuring people are investing in line with the allocations of the market. However, with markets increasingly concentrated around a small handful of stocks, global trackers’ ability to diversify portfolios have challenged.
As Darius McDermott, managing director at FundCalibre, said: “If you hold the world index, by definition, you probably hold about 70% US and 30% tech”. More than 20% of that would be in the Magnificent Seven (Microsoft, Nvidia, Apple, Tesla, Alphabet, Meta and Amazon).
Laith Khalaf, head of investment analysis at AJ Bell, explained that this was fine if investors were comfortable with this level of exposure. However, he added that recent wobbles in the Magnificent Seven’s share price due to the unveiling of DeepSeek may provide a “timely nudge for investors to check in on their overall exposure to the US stock market.”
Below, fund selectors identified a range of funds across different markets and sectors that could complement investors’ traditional global trackers.
WS Lightman European
For McDermott, the perfect complement to a global tracker would depend on “where you want your diversification”. However, he suggested that a value or income strategy would make a “good complement to a growth-dominated global index”.
He pointed to the £850m WS Lightman European fund, managed by Rob Burnett, as a good choice for this. Over the past five years, it has risen 58.3%, a top-quartile performance in the IA Europe Excluding UK sector.
Performance of fund vs the sector and benchmark over the past 5yrs
Source: FE Analytics
McDermott explained that Burnett emphasised stocks with low price-to-book and price-to-earnings ratios and attractive cashflow yields. “Burnett believes these are the best characteristics over the long-term for European shares”, McDermott added.
While the portfolio has slid into the third quartile over the past one and three years, McDermott argued that it remained a highly robust value play that investors should not underestimate.
McDermott said: “As one of the few remaining true European value funds, Lightman stands out as a contrarian complementary option”.
Vanguard FTSE Developed Europe Ex-UK UCITS ETF
Bella Caridade-Ferreira, chief executive officer at Fundscape, was also a fan of Europe. “There is plenty to like in European stock markets,” she said. She noted Europe is home to the ‘Granolas’ – 11 large European stocks that dominate its stock market, covering a range of sectors from technology to healthcare and consumer products. These include GSK, Roche, ASML, Nestle, Novartis, Novo Nordisk, L’Oreal, LVMH, AstraZeneca, SAP and Sanofi.
“Over the past three years, the Granolas have performed in line with the Magnificent Seven with lower volatility (although there was some volatility in the second half of 2023)”, Cardade-Ferreira explained.
She identified Vanguard FTSE Developed Europe Ex-UK UCITS ETF as an attractive option for passive exposure to these European stocks. Despite being a tracker, it has slightly outperformed the market, with a total return of 50% over the past five years.
Performance of the fund vs the sector and benchmark over the past 5yrs
Source: FE Analytics
She added that holding this fund would position investors well for a European resurgence. For example, ASML has reported strong earnings, while Novo Nordisk has benefitted from recent consumer enthusiasm for weight loss drugs.
Caridade-Ferreira concluded: “With everyone wishing for a magic cure for those extra inches, it looks as though Europe could do well in 2025” and would complement a world tracker.
Abrdn Global Infrastructure Equity
Katie Trowsdale, co-manager of the abrdn Myfolio Managed range, pointed to the £325.3m abrdn Global Equity Infrastructure fund. The range recently shifted its mandate to allow the managers to invest more in external funds, but Trowsdale stayed among the abrdn stable for her pick.
The fund has delivered 108.3% in the IA Infrastructure in the past 10 years. It was in the top quartile over the past three years but slid into the second quartile last year.
Performance of the fund vs the sector over the past 10yrs
Source: FE Analytics
For Trowsdale, the fund’s focus on essential infrastructure, such as transportation and energy, means it invests in businesses with stable cashflows. Additionally, she explained that infrastructure frequently benefits from cross-political government support and regulation, which brings an “extra layer of security”.
Moreover, infrastructure investments tend to have a “lower correlation with broader equity markets”. This can make investing in them an effective way of enhancing portfolio resilience and protecting from downturns that may hit the broader equity market.
She said: “By combining the broad market exposure of a global tracker with the stability and growth potential of this fund, investors can achieve a more balanced portfolio.”
Aberforth Geared Value & Income Trust PLC ex-dividend date AEW UK REIT PLC ex-dividend date BlackRock Income & Growth Investment Trust PLC ex-dividend date Bluefield Solar Income Fund Ltd ex-dividend date Care REIT PLC ex-dividend date Chenavari Toro Income Fund Ltd ex-dividend date Custodian Property Income REIT PLC ex-dividend date CVC Income & Growth Ltd GBP ex-dividend date Dunedin Income Growth Investment Trust PLC ex-dividend date EJF Investments Ltd ex-dividend date GCP Infrastructure Investments Ltd ex-dividend date Henderson International Income Trust PLC ex-dividend date Henderson Smaller Cos Investment Trust PLC ex-dividend date Marwyn Value Investors Ltd ex-dividend date Merchants Trust PLC ex-dividend date Picton Property Income Ltd ex-dividend date Polar Capital Global Financials Trust PLC ex-dividend date Starwood European Real Estate Finance Ltd ex-dividend date Taylor Maritime Investments Ltd ex-dividend date
With REITs and property companies having been heavily discounted by the market over the past two-and-a-half years, and with share prices moving inversely in eerily close tandem with gilt yields – the sharks are no longer just circling; they are taking huge chunks out of the sector.
Seven REITs and property companies were lost to M&A activity in 2024 – all at substantial premiums to share prices. Meanwhile, the boards at a further six decided to give up in their fight against persistently wide discounts to net asset value (NAV).
Private equity seems to have got the taste for blood, having tucked into some tasty deals over the past couple of years, including Tritax EuroBox and Balanced Commercial Property Trust in 2024 and Industrials REIT and Ediston Property Investment Company in 2023 – all at discounts to NAVs.
With real estate share prices tanking further, as gilt yields spiked following the budget in October, more bait has been thrown into the sea; discounts to NAV widened to an average of 35.6% at the end of 2024.
Potential private equity targets
That leaves most companies in the sector vulnerable to private bids.
PRS REIT is almost certain to go, having put itself up for sale after shareholders (unhappy at the award of an unusually long contract to its manager) pushed for the resignation of its former chairman. It is a great shame that this company– operating in a sub-sector that is exhibiting phenomenal growth drivers for the long-term – will be lost from public markets.
The question mark was always what would happen after PRS finished developing out its landbank of build-to-rent family homes. The board wanted the manager to bring forward further sites for the next phase of development. Shareholders, however, grew tired of the persistently wide discount to NAV and the inaction of the board to close it.
Whoever comes in to seize control of the company is likely to be getting a bargain. While the single-family housing market is still fairly nascent in the UK, it is attracting large sums of institutional money. Just this week Kennedy Wilson and the Canada Pension Plan Investment Board acquired a portfolio of 650 homes across the UK for £213m (average £327,000 per home), and earlier in January Greykite bought 200 homes for an average of £300,000.
PRS REIT’s portfolio was valued at £1.14bn at June 2024, equating to an average of around £210,000 for its 5,477 homes. Granted, most of the portfolio is outside of the South East (where house prices are generally higher than the rest of the country), with the majority located in the North West (52%) compared to just 11% in the South East. But as Figure 1 shows, the value of its portfolio is well below the average house price in every region.
PRS REIT’s share price, which has climbed 14% since the board was requisitioned by shareholders but still trades at a discount to NAV of 19%, implies an average house price value of £192,000 across its portfolio. This seems to be far too cheap.
The rental portfolio is in rude health. In 2024, rents across the portfolio grew 11%, which matched the uplift in 2023. Rent collection was 99%, with just a very small portion in arrears, and occupancy is running at 97%. Meanwhile, the affordability of rents (average rent as a proportion of gross household income) is favourable at 23% – significantly better than Homes England’s guidance of less than 35%.
These portfolio characteristics are indicative of the dynamics at play in the private rented sector. Challenges in the home ownership market have continued to fuel demand in the rental sector, with the median house price to income ratio at historic highs of 8.1x at the end of 2023, according to the Office for National Statistics, while mortgage rates have also risen sharply over the last two years.
Meanwhile, the UK’s private rented residential sector has lost about 400,000 rental homes since 2016, according to CBRE, due to growing cost pressures in the buy-to-let sector and higher mortgage costs.
Merger targets
Of course, it is not just private equity circling. Smaller REITs are at the mercy of their larger peers – as was the case last year with LXI REIT (bought by LondonMetric) and UK Commercial Property REIT (snapped up by Tritax Big Box).
I expect LondonMetric to continue to be knocking on boardroom doors this year, having in the last few years also swallowed up CT Property Trust (in 2023) and A&J Mucklow (in 2019). One of the industrial and logistics players may be a target. Warehouse REIT is trading on a tempting discount to NAV of 38% – although I am not sure whether its majority multi-let industrial portfolio syncs well with LondonMetric’s more single-let logistics-focused portfolio. It may well be the target of private equity, though, such as Blackstone’s industrial property company Indurent (which is the rebadged Industrials REIT).
What may be more of a match for LondonMetric is Urban Logistics REIT. However, it may prove costly to buy out the management team, whose contract was extended by three years in 2024.
The diversified ‘generalist’ REITs are all aware they need to grow to keep the sharks at bay. Custodian Property Income REIT, which missed out on abrdn Property Income Trust last year when the latter’s shareholders voted against the merger, is likely to be back on the prowl – although there is a diminishing number of targets for it to go for.
The consistently top performing AEW UK REIT could be vulnerable due to its size, at just £160m market cap, but shareholders would be reluctant to lose this company given that it has comfortably outperformed its peer group in all time periods over the last five years, whilst also paying one of the largest dividends.
Meanwhile, Picton Property (with a new chair at the helm in former Land Securities chief executive Francis Salway) is alert to the fact that it needs to grow (having launched a bid to merge with UK Commercial Property REIT in 2023, only to lose out to Tritax Big Box).
A combination of these diversified REITs would eradicate the size problem that has contributed to liquidity and persistent discounts to NAV.
Boards belatedly taking action
Boards are (belatedly in most cases) starting to take action to address wide discounts. Picton Property this week announced a £10m share buyback programme in a bid to tackle its 37% discount to NAV. This follows the launch of a similar programme by Schroder European REIT earlier in January and Urban Logistics REIT in December.
Meanwhile, the two trusts in Atrato Capital’s stable – Supermarket Income REIT and Social Housing REIT – are moving to a management fee based on share price performance rather than NAV, which we are a big fan of.
Although it could be argued that real estate discounts to NAV are a reflection of the uncertain macroeconomic environment, boards could have been more proactive. Let us hope it is not too late and we do not lose any more high-quality REITs on the cheap.
This website is for information purposes only and is not intended to encourage the reader to deal in any mentioned securities.
Why investing in dividend stocks is my favourite way of earning a second income
Instead of trying to start a business, Stephen Wright prefers to earn a second income by investing in some of the biggest and best in the world.
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Stephen Wright
Image source: Getty Images
When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.Read More
You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services.
I think inflation is a real risk for the UK at the moment. And one of the best ways of trying to combat this could be figuring out a way of earning a second income.
Warren Buffett says the best defence against inflation is being the best at something and the second best is owning shares in a quality business. I don’t see why people can’t look to do both.
Passive income
A lot of businesses distribute part of their income to shareholders as dividends. And this provides people that own shares in these companies with a source of cash that’s genuinely passive.
This is different to starting a business from scratch, or buying a property to rent out. Both of these involve significant amounts of work, which can cut off other potential ways of making money.
There’s also an issue about competition. If I wanted to try and start my own operation, I could find things difficult – or even impossible.
The stock market
The best thing about the stock market is that it allows investors like me a chance to own part of some of the best businesses in the world. This includes companies like Lloyds Banking Group (LSE:LLOY).
The bank makes money by making loans and earning interest on them. And the regulated nature of this type of industry means I could never realistically hope to set up an operation like this by myself.
This is a competitive business and customers are mostly influenced by price, which means Lloyds can’t easily charge higher rates than its rivals. But it does have an important competitive advantage.
What separates the best banks is being able to pay less interest on the cash it uses to make its loans. And with the largest consumer deposit base in the UK, Lloyds is in a stronger position than its rivals.
Strategic investing
Of course, there are risks with Lloyds. Its competitive position is strong, but there are some things – like the possibility of a sudden change in interest rates – that could still weigh on profits.
Lower interest rates usually mean narrower margins. But a sharp rise in rates is also a risk, as savers expect better returns on their deposits instantly, while loans are mostly at fixed rates.
There isn’t really a way around this for Lloyds – it’s the kind of risk that has to be managed, rather than avoided. And for investors, the best way to do this is by building a diversified portfolio.
Owning shares in businesses that are less exposed to interest rates risk can limit the overall effect on a portfolio. And the stock market offers a lot of opportunities for diversification.
Dividends
At today’s prices, Lloyds shares have a 4.7% dividend yield. And for a business with advantages that are difficult for competitors to copy, I think that’s quite attractive.
The bank’s sensitivity to interest rates means I think investors should consider it as part of a diversified portfolio, rather than as an investment by itself. But that’s why the stock market is so valuable.
