Investing for income is commonly seen as an approach favored by older individuals seeking to withdraw dividend funds while keeping the remainder of their investments intact.

However, younger investors who disregard dividends may be overlooking significant benefits. The true strength of dividends lies in their reinvestment, which can lead to massive compounding benefits. This realization is prompting me to think about incorporating a dividend-focused fund into my investment strategy.

If someone had invested £1,000 in the FTSE all-share index two decades ago and reinvested the dividends, their investment would now be worth £4,011. In contrast, without reinvestment, the value would have only reached £1,969.

Why choose dividends over bonds? The appeal lies in a dependable income paired with the potential for share-price appreciation. Although capital gains can be earned from bonds, the process is often more complicated.

For those of us who prefer not to select individual stocks, equity income funds offer a practical solution. These funds typically invest in established, dividend-paying companies such as banks, oil firms, pharmaceuticals, and consumer goods manufacturers. The UK market is particularly noted for its reliable dividend-paying companies, with funds pooling investments across various companies and distributing dividends to investors.

To harness the benefits of compounding through a fund, it is crucial to opt for “accumulation” units instead of “income” units upon investment. Accumulation units reinvest your dividends, while income units distribute them. For instance, £1,000 placed in the Artemis Income fund 20 years ago would have grown to £4,960 if you had chosen accumulation units versus £2,193 for the income units, which would have provided cash payouts along the way.

While higher growth rates may be obtainable in other areas, it’s vital to recognize that the average UK Equity Income fund has yielded a return of 30.9 percent over the past five years—far less than the 58.9 percent from average global funds or the 115.8 percent from technology funds.

Nonetheless, this doesn’t advocate for a complete shift to income funds; rather, it’s about complementing your portfolio. Even my global tracker fund offers a yield of 1.5 percent, which, when reinvested over time, can enhance overall returns.

Why the emphasis on dividends? First and foremost, a consistent dividend often indicates a company’s strong financial standing; firms with unstable finances struggle to issue dividends. Reviewing the “dividend cover” ratio can provide insight into a company’s ability to sustain its dividend—ideally, you want this figure to exceed 1. This implies a disciplined management approach and a focus on rewarding shareholders—important traits in a company.

However, it’s essential to understand that dividends are not guaranteed and can be reduced or eliminated during economic downturns, as observed during the Covid crisis. Investing in a fund helps spread risk across numerous companies, minimizing the chance that all of them will cut dividends simultaneously.

In terms of potential funds for my portfolio, I have a long-standing appreciation for the Evenlode Income team, known for its sound investment strategy. Major holdings include Diageo, Unilever, and Experian. While there is a global version of this fund, it has not performed well, ranking in the bottom quartile of its sector over various time frames.

Blackrock UK Income is another strong contender, having risen by 38.7 percent over the previous five years. Its primary holdings comprise Astrazeneca, Rio Tinto, and London Stock Exchange Group.

The Association of Investment Companies highlights an intriguing list known as Dividend Heroes—investment trusts that have increased their dividends annually for over 20 years, even through challenging times like the Covid pandemic and financial crises.

Investment trusts can manage this more effectively than open-ended funds due to a regulation allowing them to retain up to 15 percent of received dividends for payout during lean years, potentially resulting in lower distributions during prosperous times but offering security during downturns.

Several of these trusts have outperformed the average returns, lending credence to the benefits of dividends. Over a five-year period, six of the 20 Dividend Heroes have exceeded the average return of 50.5 percent across all investment trusts. In the last year, seven of these trusts outperformed, including Artemis Alpha Trust at 40.1 percent, Brunner at 37.5 percent, and Henderson Smaller Companies at 24.4 percent, against a 24 percent return for all investment trusts over the same period.

The City of London investment trust stands out by raising its dividend for an astounding 58 consecutive years, making it a compelling option. The trust, which has been in existence for over 130 years, is managed by Job Curtis since 1991. Key holdings feature BAE Systems, Shell, and Tesco.

With many years until retirement, my primary focus must remain on growth. However, investing in a reliable entity that can continue to grow even during challenging times holds significant value, especially given the potentially rocky period ahead marked by governmental budgets, a US election, and changes in interest rates.