Share solace. Not all dividends have gone to the dogs

Shares have been nosediving for what seems an eternity, but until recently a steady stream of income from dividends has offered solace for some investors, especially those who have suffered from the plunge in savings rates.

But faced with plummeting profits, more and more companies, are cutting down or even cutting out their dividends. And that means difficult decisions for those who rely on this income.

Dividends, the investor's share of a company's profits, are liable for income tax but not national insurance. They are either paid as cash or can be reinvested in the business in return for additional shares up to a value of £1,500 – an attractive proposition now as share prices are low.

Investing for income means that you aim to earn dividends above the rate of inflation, rather than increasing the long-term capital value of your shares. Income investment is generally considered less risky than growth investment, with shareholders looking for strong, consistent performance from household names rather than companies that are aiming to expand rapidly and increase their share price.

But finding that dependability is becoming challenging, says Jonathan Jackson, head of equities for stockbroker Killik & Co. "Interest rates are very low at the moment, and those who have previously enjoyed high returns from cash savings are being forced to look for more risky investments for inflation-beating yields, either from government and corporate bonds or from equities" he says. "Traditionally, dividends from companies like BT and the banks have provided good sources of this income, but BT is now cutting its dividends and many of the banks aren't allowed to issue them because of the government bailouts."

But he suggests that those who have watched their dividend payments plummet, or who are desperately seeking decent returns, can still find good sources. "Companies like BP, Shell, GlaxoSmithKline and Vodafone are returning between 6.5 and 9 per cent at the moment," Mr Jackson notes. "For this kind of yield, look for strong, stable companies, possibly with overseas earnings to take advantage of the weak pound. And by investing long term, you minimise the effect of falling share prices as they should recover over time."

For those seeking a steady income, equity income funds pool investors' money and put it in a broad range of companies in a bid to diversify and improve the chances of receiving that stable income.

The equity income sector has been hit hard by the global economic downturn and has in fact performed worse than the FTSE All Share index over the past year. But Oliver Russ, of Ignis Asset Management, believes that broadening investors' horizons could help offset this. "UK equity income is a small sector, dominated by the banks," he says. "But in Europe it's a different story. It is a much bigger investment market, banks represent a much smaller proportion and it includes a broader spectrum of industries, like Norwegian oil.

"Generating income in euros rather than sterling should also benefit UK investors as the euro is likely to remain relatively strong for the foreseeable future," adds Mr Russ.

In fact, he believes the strength of the euro against the pound may increase through 2009 in light of the UK Government's plans for quantitative easing, or printing money.