Dividend stocks vs equity income funds – three advantages of investing directly

dividend stocks vs equity income funds

Equity income funds have been popular in the UK in recent years. With savings rates at record low levels, investors have sought out other ways to generate income in retirement and flocked to funds such as Neil Woodford’s Equity Income Fund.

There are many benefits of investing in these kinds of funds. Broadly speaking, equity income funds aim to generate robust levels of income as well as capital growth over the long term. They’re usually well-diversified portfolios and typically invest in large, stable, dividend paying companies. As a result, they can make excellent core holdings for investors with a long-term investment horizon.

Having said that, there are several key advantages that the dividend stock investor has over the equity income fund investor. Here’s a look at three such advantages.

Lower fees

If you outsource your stock picking to the professionals, there are several trade-offs you need to be aware of. The first that comes to mind is fees and expenses. All mutual funds charge some form of management fee, generally ranging between 1-2% per annum. Some funds charge a one-off initial charge as well.

While a 1% fee doesn’t sound like a lot, over the long term, that 1% can turn into quite a significant sum. Think about it this way, if you have £250,000 invested in an equity fund that charges a management fee of 1% per annum, that fee will be £2,500 per year. And the portfolio manager will charge that irrespective of how the portfolio performed.

In contrast, investing directly can save investors a great deal in fees and expenses. Direct investors will need to pay brokerage fees to buy and sell securities, but once the holdings are purchased, fees can be almost non-existent, with the exception of small annual platform charges that most providers charge.

Over time, keeping fees low can make a huge difference to total investment returns.

Higher yield

Furthermore, as a direct investor, it’s possible to achieve a much higher yield than most equity income funds.

Take Woodford’s fund for example. According to Morningstar, at the time of writing, the trailing 12-month yield on this fund is 2.9%. That’s the same trailing yield as the FTSE All-share index.

With a little bit of research, it shouldn’t be too hard for the direct investor to construct a portfolio with a yield considerably higher than this.

Less reliance on market sentiment

Lastly, and this is an important, yet often ignored point, is that the dividend investor has the ability to build an income stream from dividends alone and does not need to stress about the capital value of the portfolio in the short term.

For example, let’s say a retiree has £500,000 invested in equity income funds and wishes to withdraw £20,000 per year for living expenses. If the stock market has a bad year and falls by 25%, the investor is forced to sell securities at lower prices. After the 25% decline and £20,000 withdrawal, the portfolio size is reduced to just £355,000. That’s a significant decline and could potentially result in the investor panicking and bailing out of equities at precisely the wrong moment.

In contrast, a dividend investor with a £500,000 portfolio yielding 4% can simply live off the dividend stream and not worry about the capital value of the portfolio at all. This provides peace of mind, and can make sticking to the investment strategy a great deal easier during periods of market volatility.

In summary, while equity income funds can make excellent core holdings for many investors, there are advantages of investing in dividend stocks directly. The dividend investor can benefit from lower fees, higher yields and more direct control over their income stream.

This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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