Dividends vs Growth and Tax

[Alaric]

A 12,000 CGT allowance starts to look large and appealing.

If you are influenced in investment decisions by taxation considerations, the introduction of first the £ 5000 and then £ 2000 limits on the amount of dividend that could be received free of tax for a basic rate taxpayer tilts the choice towards lower income more growth orientated stocks. So if for example receiving a lump sum that was too large to immediately shelter in an ISA, say from an inheritance, redundancy pay off, sale of business, downsizing property etc., consider how much income it will generate with a view to possibly minimising it within the requirement to spend it rather than maximising it with a view to reinvestment.

[SalvorHardin]

I’m looking at that delta between 20% and 32.5% on the Capital Gains and Dividend Tax Rates, I think SalvorHardin may be in a similar situation and understands the scenario, that’s a significant difference in tax treatment.

Yes. I'm a basic rate taxpayer living off a portfolio yield of 1.5%. I use my CGT allowance every year and usually pay a bit of CGT.

I try to avoid going into higher rate CGT, though sometimes this can't be avoided, but I'm happy to pay basic rate CGT of 10%.

Things can get tricky if I realise gains early in the tax year. I've had special dividends turn up after using up all of my basic rate allowance by realising capital gains, thus pushing me into higher rate tax. At the borders of the various allowances there's plenty of scope for reducing your taxes.

[Hariseldon58]

It is worth remembering that if you have overseas dividend income, it could be from an ETF or Investment Trust perhaps, you will very likely be to subject to foreign withholding taxes. ( you may well be unaware that you are paying these...)

With regard to the earlier worked tax example comparing tax on gains versus dividends, it’s slightly disingenuous.

Eg let’s say I require an income of £50,000 , I sell sufficient assets to bring in £50k with gains below the CGT limit of £12,000.
Tax paid zero, I may well have CGT gains of well over the £50k so I am not running down capital.

Personally I am fairly ambivalent with the distinction between gains and income. I do receive dividends and reinvest these in an isa, effectively doubling the ISA allowance for myself and Mrs Hari.

There is no best way to draw an income and I fully accept that a reliable stream of dividends is reassuring, particularly in difficult markets. However a large cash/bind reserve in a mixture of currencies is a pretty good position of strength to be able to not care too much about the day to day, month to month and year to year market fluctuations...

[JohnB]

since I retired I use my both income tax and CGT allowances equally as I wait for the long haul to get it into ISAs. for shares returning 4% dividends, and 1% capital growth above 3% inflation, both allowances would be equally used. I view total return as king, but through buy index trackers, so I'm not exposed to the startups that give you the real capital growth (or loss!)

The classic capital growth share is Berkshire Hathaway, I bet even the HYP mob wish they'd had some of that! But for every Apple there was an Apricot.

I don't worry about selling to fund my lifestyle, it will all go in the end

[Lootman]

I’m looking at that delta between 20% and 32.5% on the Capital Gains and Dividend Tax Rates, I think SalvorHardin may be in a similar situation and understands the scenario, that’s a significant difference in tax treatment.

Yes. I'm a basic rate taxpayer living off a portfolio yield of 1.5%. I use my CGT allowance every year and usually pay a bit of CGT. I try to avoid going into higher rate CGT, though sometimes this can't be avoided, but I'm happy to pay basic rate CGT of 10%.

Things can get tricky if I realise gains early in the tax year. I've had special dividends turn up after using up all of my basic rate allowance by realising capital gains, thus pushing me into higher rate tax. At the borders of the various allowances there's plenty of scope for reducing your taxes.

Involuntary corporate actions can also mess up your CGT plans, if you sell too much early in the tax year. Although usually they give an uplift to your holding value, which mitigates the pain.

I'd agree that paying 10% tax on capital gains is a relative bargain. Basic rate taxpayers should probably ensure that they realise gains up to the point where they'd become liable to the higher rate. Indeed, even paying 20% CGT might be seen as worthwhile, especially if you think such taxes are going to be raised in the future.

PS: Since you talk a lot about US rails you might try and find an article on them in last weeks Barrons. It's behind a paywall but is titled "Railroad Stocks Could Struggle as Challenges Mount". I hold only Union Pacific but have been thinking recently about CP and CSX.

[dspp]

I’m looking at that delta between 20% and 32.5% on the Capital Gains and Dividend Tax Rates, I think SalvorHardin may be in a similar situation and understands the scenario, that’s a significant difference in tax treatment.

Yes. I'm a basic rate taxpayer living off a portfolio yield of 1.5%. I use my CGT allowance every year and usually pay a bit of CGT. I try to avoid going into higher rate CGT, though sometimes this can't be avoided, but I'm happy to pay basic rate CGT of 10%.

Things can get tricky if I realise gains early in the tax year. I've had special dividends turn up after using up all of my basic rate allowance by realising capital gains, thus pushing me into higher rate tax. At the borders of the various allowances there's plenty of scope for reducing your taxes.

PS: Since you talk a lot about US rails you might try and find an article on them in last weeks Barrons. It's behind a paywall but is titled "Railroad Stocks Could Struggle as Challenges Mount". I hold only Union Pacific but have been thinking recently about CP and CSX.

It is worth keeping an eye on the reducing volume of coal being used in the US. I am guessing that is what will be in the Barrons article (as well as any downturn) and I too have wondered if that might affect SH's railroad picks.

regards, dspp

[SalvorHardin]

P.S: Since you talk a lot about US rails you might try and find an article on them in last weeks Barrons. It's behind a paywall but is titled "Railroad Stocks Could Struggle as Challenges Mount". I hold only Union Pacific but have been thinking recently about CP and CSX.

Can't see the article, but based on what I've seen elsewhere the challenges are probably a mixture of declining coal, tariffs affecting import and exports, possible recession and competition from trucks.

Union Pacific and the other West Coast rails (Canadian Pacific, BNSF) are much less exposed to coal and trucks (longer average distances for UP) compared to east coast CSX. UP's business is cyclical as it is highly dependent on the US economy, but I'm less concerned about a US recession than most pundits.

I reckon that the US media is talking up a recession mostly to bash Trump - the modern economy seems to be mixture of several business cycles rather than a single business cycle (e.g. car industry going into recession; IT booming)

[Itsallaguess]

The best place to find growth shares is overseas stock markets and amongst the smaller companies quoted in London, not the FTSE100 which yields more than twice the S&P500.

There are a few growth companies in the FTSE100; I’d pick out Burberry, Diageo, Smith & Nephew and Unilever (my four largest UK holdings).

When it comes to growth shares London doesn’t offer anything that can match Wall Street’s technology sector. Or even the North American railroads, a 19th century technology with spectacular growth in recent years. But these companies don’t get talked about much on TLF.

One of the more sobering investment comparisons I often have to re-visit is when I compare some of the 'growthier' Investment Trusts that I've invested in for my son, and pitch some of them against my 'higher-yield' Investment Trusts that I own myself.

When it comes to investing for my son, I've been very careful to deliberately fire-wall my own income-orientated investment approach, and I often tend to look for longer-term growth that might be available where he hopefully has a much longer investment-horizon available to him, and one of the early Investment Trusts that I purchased for him was Monks IT (MNKS).

I'm a great believer in diversity when it comes to my own income-investment, and high-yield Investment Trusts are, for me at least, a great way to easily achieve a good level of diversity from my investments. When I started to invest for my son, I took the view that a similar approach to diversity could be taken with a more growth-orientated strategy, and looked for some Investment Trusts that gave a wider stock and geographical spread than one which I might reasonably achieve myself without too much work or stock-specific risk.

For this comparison, I'll use what I consider to be a very close 'HYP-Proxy' Investment Trust that I own, which is City of London (CTY), and below is a five-year total-return chart comparing City of London with Monks -



Clearly, on a total-return basis there is little comparison to be made, although it should also be noted that Monks does display a level of volatility that needs riding through during general market-downturns, with July 2018 to July 2019 being a good example of the kind of swings that we can be exposed to with this type of approach.

HL source used to generate above chart - https://www.hl.co.uk/funds/fund-discounts,-prices--and--factsheets/search-results/f/fundsmith-equity-class-i-accumulation/charts

Trustnet links here for anyone interested in the underlying stocks and geographies of the above two IT's -

Monks - https://www2.trustnet.com/factsheets/factsheet.aspx?skipre=1&fundCode=ITMNKS&univ=T

City of London - https://www2.trustnet.com/Factsheets/Factsheet.aspx?fundCode=itcty&univ=T&pageType=overview&skipre=1

On a more general point, I agree that a more specific 'Growth Investment' area of the site would be warranted, and have raised this with the powers that be to see if there's anything we can do to promote that.

Cheers,

Itsallaguess

[PinkDalek]

Hi All, I am relatively new to the TLF and as an income seeker it suits me very well in the main. But I guess that I am surprised that there is no obvious board (or set of boards) dedicated to discussing growth stocks. I guess any user could create a topic in Investment Strategies but this hardly gives it the equal footing that it probably deserves ?.

I really dont know how one goes about requesting the addition of a new top level board here, maybe there is a mechanism - but if so I am unaware of it.

Suggestions for potentially improving The Lemon Fool can be made at the Biscuit Bar.

There’s a Poll [1] there that Clariman created following Discussions of opening a Value shares board (and another). I haven’t read the 5 pages of discussions again but I’m sure Growth would have been discussed over there. The Poll thread is locked and one can find the ‘holding’ conclusion back on the Value Board thread [2] over there (which is still open for comments).

[1] https://www.lemonfool.co.uk/viewtopic.php?p=162573#p162573
[2] https://www.lemonfool.co.uk/viewtopic.php?p=164632#p164632

[Lootman]

For this comparison, I'll use what I consider to be a very close 'HYP-Proxy' Investment Trust that I own, which is City of London (CTY), and below is a five-year total-return chart comparing City of London with Monks -

Clearly, on a total-return basis there is little comparison to be made

On the face of it, it's not surprising that the growth IT has out-performed the income IT by some measure. I would expect that, whilst anything can happen in shorter time periods, over a longer duration an investment in companies that reinvest and grow their earnings will give superior returns to an investment in mature companies that pay out most of their earnings in dividends. Essentially when you gorge on jam today, you accept that there will be less jam tomorrow. Jam today might be the right decision for some, but in general rewards accrue to those who are patient and defer gratification.

Note also that since these are total return numbers they do not (I'd assume) take taxes into account. That is fair enough for the purpose of a neutral comparison. But since the topic here is about how returns are taxed, then the results actually flatter CTY. The reason being that more of the total return from City is in the form of dividends, which would be taxed every time they are paid out. So whilst the numbers assume dividends are reinvested gross, in practice you had to pay income tax on those dividends. So on an after-tax basis, those reinvested amounts should be computed net of the tax rate you pay on them. Monks, having much lower dividends, derives more benefit from internal growth and has less frictional loss due to tax. That said, you will get a bigger CGT hit if and when you finally sell. But until then tax hits City harder. And even if CGT rates and income tax rates are the same, you pay more tax on City at any point up to a sale.

I don't think this proves that growth beats income. There are other variables here such as UK versus global, the skill or luck of the individual manager, and the degree of borrowing the ITs used. A better comparison might be between a growth index ETF and an income index ETF. But I'd need a reason to believe that the outcome would be much different, given the size of the difference between the two outcomes here.

[BrummieDave]

I don't think this proves that growth beats income. There are other variables here such as UK versus global, the skill or luck of the individual manager, and the degree of borrowing the ITs used. A better comparison might be between a growth index ETF and an income index ETF. But I'd need a reason to believe that the outcome would be much different, given the size of the difference between the two outcomes here.

Comparing Monks, a global growth IT, with City, a UK focused income seeker, is a tad misleading.

[monabri]

-

Interesting to see when the "divergence" between the returns on the two funds started!

I also note that Witan has decided to reduce its UK holdings - perhaps thoughts of poor investment returns due to a poor Brexit outcome?

viewtopic.php?p=252736#p252736

[Itsallaguess]

I don't think this proves that growth beats income. There are other variables here such as UK versus global, the skill or luck of the individual manager, and the degree of borrowing the ITs used. A better comparison might be between a growth index ETF and an income index ETF. But I'd need a reason to believe that the outcome would be much different, given the size of the difference between the two outcomes here.

Comparing Monks, a global growth IT, with City, a UK focused income seeker, is a tad misleading.

It was me who posted the total-return comparison chart of Monks vs City of London, and given that it was done so as a direct reply to SalvorHardin, who said this -

The best place to find growth shares is overseas stock markets and amongst the smaller companies quoted in London, not the FTSE100 which yields more than twice the S&P500.

There are a few growth companies in the FTSE100; I’d pick out Burberry, Diageo, Smith & Nephew and Unilever (my four largest UK holdings).

When it comes to growth shares London doesn’t offer anything that can match Wall Street’s technology sector. Or even the North American railroads, a 19th century technology with spectacular growth in recent years. But these companies don’t get talked about much on TLF.

and that such a reply was done on a thread discussing 'Dividends vs Growth', then can you please explain exactly what you mean by 'misleading', as it's not entirely clear what your point is...

Cheers,

Itsallaguess

[77ss]

TJH,

Both the SIPP and ISA have strict limits on how much you can invest.
And I’ve invested to the maximum that was allowed, consistently since inception.

I’m addressing funds held outside those shelters.
In my original post I should have said “ why don’t more investors pursue Growth in addition to Income?” instead of “why don’t more investors pursue Growth rather than Income?
I find the tax advantage quite compelling, but maybe I’m alone in this?

MAD

We are all in different positions. I get approximately 60% of my income from dividends (40% from pensions) and my total income is slightly largely than my expenditure, so I can afford to look somewhat to growth and I have some protection against a bear market. Last time I looked, I could ride out a 30% fall in dividend income - maybe at the cost of some of my exotic holidays if the worst comes to the worst - not really a problem.

Like you, I move as much as I can into ISAs and SIPP every year. I've been doing this for 15 years now, ever since taking early retirement, and I am still about 45% unsheltered. Easier if you have a partner perhaps.

Turning to your question. I don't find the tax advantage wholly 'compelling'. Mix and match works for me. I like some unsheltered dividend income (but higher rate payers will doubtless feel differently) and I also like capital gains - so I have a mixture of holdings. This gives me some direct income, and over the past 14 years I have been able to use the annual CGT allowance in every year except one.

Partly compelling, I guess. On the whole, my more modest yielders are now giving me a better total return. 10 years ago it may have been different but I suspect that the HYP heyday is over.

[dealtn]

For me it is absolutely about "total return". As part of that I favour a form of return that has the lower tax penalty. Not only are capital gains taxes lower than on income, but (in the main) I can choose when to crystalize, and pay, them. Unrealised, and untaxed, capital gains that continue to compound are far superior to suffering a "tax drag" in my opinion.

For sure there are those who take comfort in the "regularity" of dividend income, and are put off by the "complexity" of making adjustments to their portfolios, and making "sell" decisions to "create" income.

To me this isn't about "growth" shares versus "income" shares. I own plenty that fall in either camp. But it is fundamental to me that total return is what I am looking at in making my investment choices. Indeed I would hope never to receive a dividend from a "HYP" type share should I make an investment in one.

[scrumpyjack]

For me too it is all about total return.

I am realising a lot of large capital gains at present because I think there is a significant chance of a major increase in the CGT rate in the next couple of years. I suspect both a Labour and Libdem administration would tax them as income without any allowance for inflation and at the increased income tax rates they would introduce.

[77ss]

....
One of the more sobering investment comparisons I often have to re-visit is when I compare some of the 'growthier' Investment Trusts that I've invested in for my son, and pitch some of them against my 'higher-yield' Investment Trusts that I own myself.....

For this comparison, I'll use what I consider to be a very close 'HYP-Proxy' Investment Trust that I own, which is City of London (CTY), and below is a five-year total-return chart comparing City of London with Monks ....

......
Clearly, on a total-return basis there is little comparison to be made, although it should also be noted that Monks does display a level of volatility that needs riding through during general market-downturns, with July 2018 to July 2019 being a good example of the kind of swings that we can be exposed to with this type of approach.

Sobering indeed, for all CTY holders. CTY is just an FT All Share tracker with about 90% in UK stocks, whereas Monks has a mere 6% in the UK, so one is not really comparing like with like. If one has a basic long term hold approach I don't see that capital volatility is an issue.

Interesting to note that CTYs performance really started to diverge from other ITs mentioned in July 2016. If there is a sensible Brexit outcome will this reverse? CTY as a political gamble? With a reliable dividend? I don't intend to buy, but its a thought.

[Alaric]

CTY is just an FT All Share tracker with about 90% in UK stocks, whereas Monks has a mere 6% in the UK, so one is not really comparing like with like.

I thought that was the point of the comparison. A UK orientated HYP like strategy against an international global growth one.

[Itsallaguess]

CTY is just an FT All Share tracker with about 90% in UK stocks, whereas Monks has a mere 6% in the UK, so one is not really comparing like with like.

I thought that was the point of the comparison. A UK orientated HYP like strategy against an international global growth one.

Quite...

As I've said earlier in the thread, this comparison was made in direct reply to another poster who was discussing exactly the same comparison of two completely different approaches..

For anyone to say that pitching City of London against Monks isn't comparing 'like with like' has missed the clearly obvious point that it was never meant to....

Cheers,

Itsallaguess

[Julian]

Almost all the talk so far has been income vs growth ITs. I think it's also worth pointing out that, for those comfortable/willing to include capital selloffs as part of their annual income harvesting, it also opens the door wider to passive investment strategies that may be of interest to some.

For instance I have one of my biggest single holdings in Vanguard's FTSE Developed world ex-UK(*) tracker (https://www.vanguardinvestor.co.uk/inve ... ome-shares) which is currently listed by Vanguard as having a 1.63% yield. Given that I need more than that to live off (I live entirely off investments) this wouldn't be a viable holding for me were I living entirely from dividend payouts, or at least it would be a drag on my portfolio such that, in order to offset the low Vanguard yield, I would have to blend it with a lot of other holdings that would need to be at high enough yields to probably cause me concern which would not be a path I would want to go down. For my Vanguard holding, and my other passive trackers, I think of their dividends not as an income distribution that I am going to live off but as a pre-release of capital during the year that will reduce the actual capital sell-offs(**) I need to do at the end of the year to extract the income that I want.

I like the concept of a passive investment strategy so the ability to run such a strategy alongside my income (high yield) investments is a big benefit to me and, since I do live off my investments and need to extract a certain level of income from my assets each year, being open to capital sell-offs makes this possible for the reasons mentioned in the paragraph above.

- Julian

(*) Ex-UK because I have a reasonably sizeable set of HYP shares that are all UK-listed.

(**) Those selloffs might not necessarily be in that particular Vanguard fund but the dividends it paid out during the year still serve to offset the year-end capital sell-offs required whatever holdings end up being top-sliced at the end of the year.