Thanks, Mareea. Just to clarify the point you raised, you’re quite right that at one time there was a tax on dividends even in ISAs. That was under the old (and confusing) system where a 10% “dividend tax credit” was applied, which investors in individual shares could reclaim but investors in funds couldn’t. That was scrapped from April 2016, though, and now all dividend income in ISAs is tax free, whether via individual shares or funds. That is my understanding anyway.

Hi Lewys and Nick
Many thanks to you both for your comprehensive replies. Couple of observations:

Nick, glad you’re with me on the funds – reassuring! I agree there no guarantees; I have a fairly diverse portfolio – not keeping my eggs in one basket. As a relatively new investor, I also plan to reassess every year and change my ISA distribution (ie, l won’t buy more of the worst performers; I’ll buy something else instead). I tend to go for passive funds too, as they seem to perform as well as actively managed funds over the long term, with far lower fees.
Thanks for the clarification on tax; I was under the impression that dividends were taxed even in an ISA; nice to know that isn’t the case (yet!)

Lewys,
Re point 1: as I mentioned, I get the logic of dividend stocks for people near retirement, but for people a decade or more away, I’m still not clear as to why you wouldn’t go for growth stocks/funds at first and gradually move towards dividends as the finish line gets closer (obviously not selling any off cheap!)? That’s my strategy ATM; I’m aiming to retire early but nowhere near as early as you plan to, so I have a more limited time to increase my pot, hence why I”m aiming for growth rather than income. I do have other sources of potential retirement income; my personal pension is in a more conservative fund (but still returning a fairly steady rate of around 6-7%), so I’m happy to be a bit more adventurous with my ISA as that will fund the gap before I can access the pension.
Re point 2: OK, so you reckon funds are better as one approaches retirement? That’s good, because I’m a bit older than you! 😉
Re point 3; agreed, but what’s the risk ratio with those top-performing stocks vs funds? My worry is that individual stocks would be more volatile than funds because the funds are spread wider. And as you say, it’s a question of identifying those stocks in the first place, and I just don’t have the time! It seems to be a lot easier to identify good-performing funds, as all the newpapers publish lists regularly, and although past performance is no guarantee of future returns (yadda, yadda), I’d rather bet on Man Utd than Accrington Stanley! Hence, all of the funds I’ve chosen have been solid performers for at least 10 years, and importantly have low fees. This seems to be working so far (touch wood); my YTD ROI is 28%, so I’m hoping this will continue!

Thanks again for your time!

@Mareea

Firstly thanks for the question! I always LOVE questions and was unaware that my comment facility on the homepage was down :(.

I’ll take on the points you’ve raised one by one :).

1. “I’m puzzled as to why so many investing/FIRE blogs use dividend stocks as their main/sole strategy. I can understand that’s a sensible approach for people at/close to retirement like yourself, Nick, as it provides income without depleting capital, but for people who are 20, 10, maybe even 5 years from retirement, I don’t get the logic behind it.”

I think the main reason here is due to being able to have an income without the need to ‘drawdown’ from any capital gain.
If we have to sell stocks in order to access money then we incur fees and this money will eventually run out at the early retirement ages many FIRE blogs aim for. If one is seeking to retire at a later age then there’s a lot less risk of this money running out as there are less years of retirement to fund.

For me, I want to retire at 40 years old and even if we estimate a conservative 35 years of retirement, I wouldn’t be comfortable constantly selling for an income ESPECIALLY as the market can easily take a harsh correction and I want to be in a situation to buy more or hold during these years without the need to sell at cheap valuations just in order to live.

2. “On Lewys’ own blog (which doesn’t seem to have any comments facility, hence why I’m raising the issue here), his guide to investment strategies suggests funds (managed, passive, or robo-invested) as the easiest and safest forms of investing, so why does he go for individual stocks? And why dividends rather than growth? Particularly as dividends are taxed but growth isn’t, and many investment platforms also have a charge for reinvesting them?”

VERY good point! The reason I recommend these types of passive investing is that these are the types that require the least effort, the least risk for the most gain. I’m in the very fortunate position (financially) of having no current liabilities (kids + mortgage for example) and can therefore afford to take on this extra risk for potentially a little more reward. I’m also only 24years old, so I can afford to make mistakes here and there as time is on my side. The older I get, the more I’ll transition into funds.

As for growth, growth companies tend to sport high p/e ratios meaning that a lot of the ‘growth’ investors speak of is often baked in. These stocks often take massive dips on even slightly disappointing results. They also tend to be smaller-cap companies with a lot of risk ahead. Why buy these companies when I can buy proven bluechips at more reasonable valuations without the need to bite my finger nails waiting for future growth that may never materialise.

3. It’s not like funds are low-yielding either; the top 10 highest-performing funds are currently giving an annualised return of between 26% and 32% (and no, there isn’t a decimal point missing!). Even allowing for fees (I personally avoid any above 0.8%), that is a much higher yield than those quoted above for dividends.

If you took the top 10 highest performing stocks you’d be looking at returns in the 100s if not 1000s of %. The trick of course is finding these stocks/funds beforehand. If you could identify the funds that will return 32% next year, I’ll certainly be willing to invest!

Thanks so much for your question!
Anything else you’re itching to ask I’ll be more than happy to reply,
Lewys

Thanks for raising some interesting points. Obviously Lewys knows more about this subject than I do, so I have written to draw his attention to your comments, in case he wishes to respond to them.

I would just like to make a couple of points of my own, though. First, I am with you insofaras generally I prefer to invest in funds rather than individual stocks. However, while some funds have delivered very good returns over the last few years, there is no guarantee that any particular fund will continue to do so. You only have to check out the recent performance of Neil Woodford’s funds to see that past performance is no guarantee of future profits. With “safe” stocks such as the ones Lewys is advocating, on the other hand, you do have a reasonable guarantee that dividends will continue to be paid at around this level year after year, regardless of how the stock market overall performs.

Also, it’s not strictly true that “dividends are taxed but growth isn’t”. In an ISA wrapper neither are taxed, but outside this wrapper both may be. There is currently a £5,000 annual tax-free allowance for dividend income (still quite generous). Price growth of shares or funds outside an ISA may result in a CGT liability if it exceeds the annual allowance, which is currently £11,300. That is obviously even more generous than the dividend allowance, but if you dispose of a large taxable asset in the year in question you could easily use it up. Of course, CGT normally only applies when you dispose of the asset in question, which leaves more scope for tax planning.

Anyway, I’ll leave it to Lewys if he wants to add anything else, but thanks again for taking the trouble to comment in such detail.

On Lewys’ own blog (which doesn’t seem to have any comments facility, hence why I’m raising the issue here), his guide to investment strategies suggests funds (managed, passive, or robo-invested) as the easiest and safest forms of investing, so why does he go for individual stocks? And why dividends rather than growth? Particularly as dividends are taxed but growth isn’t, and many investment platforms also have a charge for reinvesting them?

It’s not like funds are low-yielding either; the top 10 highest-performing funds are currently giving an annualised return of between 26% and 32% (and no, there isn’t a decimal point missing!). Even allowing for fees (I personally avoid any above 0.8%), that is a much higher yield than those quoted above for dividends.

I’m very happy with how my funds are performing in my ISA, but I have this nagging feeling I must be missing something! Can someone pleae explain why dividends are a good choice for people who don’t actually need that income?

Thanks Lewys for clearing that up.

Thanks for the comment. I guess that might be a good subject for another post 🙂

Thanks for the clarification. That special dividend looks to have been a nice little bonus for shareholders then. 🙂