Receiving dividends is tax-free inside a limited company. Should you choose a dividend fund or a global tracker when investing as a limited company?
This article compares the performance of dividend funds with global equity funds for limited company investors.
My judgement is data-driven. I compare funds and indices.
I also look at the comparison before and after tax.
Tax might not be very relevant in an ISA or SIPP. But it plays a big role when investing inside a limited company or in a General Investment Account.
Even though this article is somewhat geared towards limited companies, the facts are useful to ISA and SIPP investors as well.
The results might surprise you!
- Global trackers outperformed dividend funds after 2008
- During 1994-2023, dividend investing performs better
- Limited companies can benefit from dividend investing thanks to tax benefits
- Finding good dividend funds is hard (but I provide a few options)
Note: A 'tracker fund' can technically track any index. When I refer to a 'global tracker' I mean one that tracks a broad equity index (e.g. FTSE All-World or MSCI World) which attempts to track the entire investable universe in developed and emerging markets.
Let’s start with the most popular dividend ETF in the UK in terms of size.
Take Vanguard’s All-World High Dividend Yield ETF (VHYL)
This fund invests in global companies with high dividends. As of April 2023, it pays 3.80% per year. Almost double what a global tracker pays (2.00%).
Distributions happen every 3 months.
Naturally, it does not include as many companies as the global tracker does. The dividend fund invests in 1,812 stocks vs 3,782 for VWRL.
What’s in a dividend fund?
As of March 2023, here are the top 10 holdings of a dividend tracker (VHYL), next to the global tracker ones (VWRL).
|Top 10 High Yield||Top 10 All-World|
|Exxon Mobil Corp.||Apple Inc.|
|JPMorgan Chase & Co.||Microsoft Corp.|
|Johnson & Johnson||Amazon.com Inc.|
|Procter & Gamble Co.||NVIDIA Corp.|
|Chevron Corp.||Alphabet Inc. Class A|
|Home Depot Inc.||Tesla Inc.|
|Nestle SA||Alphabet Inc. Class C|
|AbbVie Inc.||Exxon Mobil Corp.|
|Merck & Co. Inc.||UnitedHealth Group Inc.|
|Bank of America Corp.||JPMorgan Chase & Co.|
If we look at the dividend fund sectors, Tech only makes 10% of the dividend index. A Global tracker has a 21% allocation in tech as per the fund’s factsheet.
MSCI provide a High dividend Yield index. Here are its sectors and country weights.
Banks, consumer staples and healthcare dominate the dividend index.
The global tracker on the other hand is dominated by Technology, Financials and Consumer Discretionary (Home Depot, Starbucks, McDonald’s etc) in that order.
Tech does not pay much in dividends and therefore, makes a much smaller part of a dividend fund.
Let’s do some performance comparison and let the money talk. Who wins?
High Dividend Yield Fund vs Global Tracker, Round One (2013-2023)
One way to compare a dividend fund with a global tracker is to compare two ETFs.
One that focuses on high dividends versus a global tracker ETF.
I will choose the most popular options out there, which also come from the same index provider, FTSE:
- Global tracker = VWRL – Vanguard FTSE All World
- High Dividends = VHYL – Vanguard FTSE All-World High Yield
Here is the comparison, assuming income is reinvested, using Trustnet charts.
As you can see, the Vanguard FTSE all world is a clear winner.
Had you invested £100,000 in 2013, your investments would be worth about £250,000 in 2023 in VWRL, versus £200,000 in the VHYL dividend fund. Both funds reinvested the dividends throughout the period.
And in Annualised Returns between 2013-2023:
|Global Tracker (VWRL) Annualised Return||High Dividend Yield (VHYL) Annualised Return|
Overall, since 2013, you would be better off with the Global tracker, instead of these seemingly juicy dividends.
But what about tax?
If you invested in an ISA or a SIPP, there’s really no difference.
But for those investing in a limited company, a dividend fund has better tax treatment.
That’s because dividends received from VHYL are not subject to corporation tax.
Most of the gains in Vanguard’s high-yield fund come from dividends. The yield is close to 4%.
While most of the gains in a global tracker come from capital gains and are therefore taxable.
The global tracker’s dividend yield is about 2%, much lower than the 4% for the high-yield fund.
However, even if we consider the worst taxation for VWRL, and assume the entire profit is taxed, it still ends up ahead.
So for example, with a starting value of £100,000, and an ending value of £250,000, we would make a £150,000 profit.
After 25% corporation tax, this would be £112,500. Still higher than the £100,000 profit for the dividend fund, about half of which needs to be taxed too.
Why did global trackers outperform dividend funds since 2013?
Tech likes to keep its earnings
Most tech companies do not pay dividends and prefer to reinvest their earnings in themselves.
Funds that focus on dividends exclude companies such as Google and Amazon, and these companies were the name of the game in the bull market of the 2010s.
The case for investing in VWRL over dividend funds after 2008 was obvious in hindsight. A long bull market, boosted by mega-cap tech companies such as Apple, Google and Facebook (FAANG) made the VWRL a clear winner here.
Share Buyback companies not included
The Shares Buyback trend is also something dividend funds missed. After 2008, many companies decided to reward their shareholders in a different way.
Investors have to pay taxes on the dividends they receive. No, not in your ISA, but in the US and probably elsewhere too.
Whereas if your shares appreciate in value, YOU get to decide WHEN to sell them. Dividends have to be taxed the tax year they are distributed.
Therefore, US investors prefer capital gains over dividend income for tax reasons.
In other words, they’d rather see their share price move higher instead of getting dividends in their brokerage account.
So companies began to buy back their own shares with the dividend money, instead of distributing it to shareholders. This boosts their share price and saves (or rather defers) investors’ taxes.
It also gives some flexibility to investors. They would rather be the ones choosing when to take the tax hit, by selling shares instead of receiving regular dividends.
Shares buybacks make some company ratios appear to be healthier too. For example, Earnings Per Share would go up if the same earnings are distributed to fewer shares (because the company bought back some of its own).
So this financial engineering helps them look better and pay hefty exec bonuses that are tied to these metrics…
But to close this parenthesis – Dividend funds would have included Apple if it paid a 5% dividend, instead of buying back 5% of its shares. But they don’t.
So in the 2012-2022 period focused on growth, zero-interest rates and share buybacks, the dividend funds lagged behind.
If we compare funds since 2012, dividend funds underperformed world trackers.
But 10 years is not long enough to draw any meaningful conclusions.
I would love to get my hands on some good data, but these funds only started around 2012. Instead of comparing funds, a better way to do it is to compare Indices.
Funds track an index. An index provider (e.g. FTSE or MSCI) would issue a ‘High dividend index’ which defines what companies a dividend fund must hold to implement it. Here’s the MSCI high dividend fund methodology if you’re interested.
This is how most ETFs work. For example, HSBC MSCI World UCITS ETF tracks the MSCI World index. So instead of investing with HSBC, you could achieve almost identical performance by choosing the Xtrackers MSCI World UCITS ETF from DWS Deutsche Bank.
Now that we established Index data is a better comparison than funds, let’s see if we can go back further in time.
FTSE is not kind enough to offer index data to retail bloggers like me. But, thankfully, MSCI does!
2008-2023: Dividend Fund vs Global Tracker investing as a limited company
Let’s use MSCI index data to compare a global tracker versus a dividend fund before and after corporation tax. Corporation tax is what limited companies pay when investing.
MSCI All Country World Index vs MSCI All Country World Index High Dividend Yield
Here’s a quick glance comparison using the MSCI’s factsheet:
The MSCI data post-GFC paints the same picture.
Before-tax, investing $100 in ACWI would more than double your money (260% in 15 years, in dollars). Investing in the MSCI dividend tracker would offer 229%, slightly lower.
In GBP currency the numbers are higher because the dollar became much stronger against the British pound during that period. One British pound in 2008 could buy you 2 dollars. Right now, it buys just $1.23.
So a weaker currency would “boost” your returns when measured in the latter. The MSCI all world would return 386% in Sterling (vs 260% in USD)!
This is another reason to invest globally. You never know what’s going to happen with your own currency, economy, housing market etc.
But here’s the kicker:
What if we consider how funds are taxed inside an LTD company?
Would the dividend fund outperform an all-world tracker after taxes?
During 2008-2023, a global tracker would still outperform the High Dividend yield fund, even after accounting for corporation tax.
Without considering taxes, the All World tracker is 18.7% ahead of the dividend fund in GBP terms.
After paying the appropriate corporation tax on the capital gains, the global tracker is still ahead by 12.8%
So despite the more favourable tax treatment, the dividend fund is still behind between 2008-2023.
The difference, however, drops from 18.7% before tax, to 12.8% after tax.
Better fund taxation ‘improved’ the dividend fund results by 6% in 15 years.
It makes sense because dividends are corporation tax-free in a limited company. As a result, you would expect the dividend fund to improve its relative performance against a capital-growth fund after considering taxes because a bigger part of the returns is dividends.
But yes. As we see above, even in the scenario where a LTD company invests, the global tracker is still ahead.
For comparison purposes, I assumed that the entire holding is bought in 2008 and sold in 2023.
Yes, yes, I know this is not likely to be the case. People sell only what they need and things like salaries, business expenses, and pension contributions will lower the actual corporation tax.
But assuming the ‘worst case scenario’ for corporation tax, a global tracker beats dividend investing for limited companies between 2008-2023.
Round 3: Dividend Fund vs Global Tracker 1994-2023
They say you can tell any story you want if you choose the right time frames…
Despite the All-world tracker dominance in the past 15 years, the picture changes if we look at 20 or 30 years of history.
Since 1994, High Dividend Yield beats MSCI All World tracker by a large margin!
£100,000 invested in an MSCI dividend fund in 1994 would be worth £1.6m in 2023. An MSCI global tracker would be worth about £1m.
|MSCI All Country World||MSCI High Dividend Yield|
And that’s before considering the better tax treatment of dividends inside a limited company.
The picture is similar for the period 2000-2023 as well. The dividend fund is ahead if we include dividends.
Data note: In the real world, a foreign tax office would deduct some percentage (0% - 30%) from dividends before distributing them to international investors. The dataset only offers Gross dividend treatment (no tax deduction) since 1994, and only Net dividends since 2001. So the gap would close a bit in favour of the Global tracker, but the difference would still be significant. For example, between 2001 and 2023, the gross dividend comparison fund is ahead by 16.1%, but only 8.9% when using Net dividends.
Why did the dividend fund outperform the global tracker since 1994?
The dividend fund did not lose so much value in the Dotcom crash of 2000, and consistently outperform up until 2008.
Perhaps this is more obvious if we see the chart in LOG terms.
Since 2008, the Zero Interest Rate Policy (ZIRP) era boosted growth companies, instead of value.
Inflation was low and global interest rates stayed low. Investors were more willing to reward companies with projects which can take a long time to yield results.
The cost of borrowing was cheap, and so was the cost of investors’ capital. With low inflation, investors were more patient.
The ‘price of money’ was cheap.
Since 2022, the landscape has changed. We no longer have zero rates. In fact, during 2022-2023 central bankers made the fastest rate hikes in history. From zero to 5% in the US (4.25% UK and rising).
Some say we will not go back to the previous low-interest rate world. IMF thinks we will.
But one thing is clear: A global tracker had beaten a dividend fund only for certain periods. Not always.
As we see above, history tells us there are reasons to choose a dividend tracker over a global tracker, especially inside a limited company where taxation is guaranteed to be better with current rules.
Here are the arguments on both sides:
Reasons to Choose a Global Tracker Fund over a Dividend Fund when Investing as a Business
Despite the 30-year outperformance of dividend funds, there are good reasons to choose a global tracker over a dividend fund when investing through your limited company.
1. Innovation and growth
First of all, why exclude hugely profitable companies from your portfolio like Apple, Amazon and Google? You would, at the same time, exclude big innovators, because a lot of innovation happens in tech, which typically doesn’t pay dividends.
An all-world equities fund, also known as a global tracker, gives you access to almost all companies in the world. The dividend fund, on the other hand, focuses only on companies distributing dividends.
If OpenAI or Stripe get on a stock exchange, they probably won’t be paying dividends. You might miss out on a few companies that make it BIG. What if in the future performance comes from these few companies? I’m not saying that’s a good thing but place your bets accordingly if it does.
2. Truer Passive Investing
If you follow the passive investing approach, market purists say you should be holding all companies according to their market capitalization.
By choosing a dividend fund, you would be diverging from the “true” passive investing mantra and engaging in some form of factor investing.
As we saw above, dividend funds worked better during 1994-2008 but performed worse from 2008-2023.
3. High dividend companies do not re-invest in their growth
High dividend-paying companies don’t re-invest their earnings into their own projects to the same extent low or no-dividend-paying companies do.
Dividend companies prefer to pay money out to shareholders. Is it because they put shareholders first or is it perhaps because they don’t have a great use case for the capital?
By investing in an all-world tracker you benefit from the entire economic output as much as possible, and don’t discriminate against companies based on one factor.
4. High dividend yield ETF options are very limited
Seems like we only have a few UK options for high-dividend funds. MSCI High Dividend Yield ETFs have changed to now track an ESG dividend index instead.
Then there’s always the Vanguard FTSE All-world High Dividend Yield ETF (VHYL). But this is a shame because FTSE does not make the data available since 1994 as MSCI does. Did FTSE High Dividend Index outperform its global tracker?
For all ETF options see the section below.
Reasons to Choose a Dividend Fund over a Global Tracker when Investing through a Business
Choosing a dividend fund instead of a global tracker becomes an easier choice if you consider
- The outperformance since 1994
- Better tax treatment for limited companies
- The behavioural benefits
1. Dividend funds outperformed over a 30-year period
The MSCI High Dividend Yield Index performed better than the MSCI All Countries World Index (ACWI) from 1994-2023.
So choosing a dividend fund can yield better results.
For a company to pay dividends, it is usually profitable. This means you would be investing in a company that makes money. I know this sounds obvious, but even huge companies like Tesla took many years before they became profitable.
2. Better tax treatment for Limited Companies
As long as tax law remains the same, limited companies have a guaranteed advantage when investing in dividend funds over other funds.
LTD company investors have a head start over global tracker investors because dividends are not usually subject to corporation tax.
As a result, you get to keep more of the returns your fund generated.
This is not the case for General Investment Accounts (GIA) for individuals. Depending on your personal tax band a dividend might work better or worse compared to capital gains. I’m talking about those individuals (not companies) who hold accounts outside an ISA or a pension.
3. Easier to hold – Behavioural win
With a dividend fund, you are getting paid for just holding stocks. How cool is that 🙂
Theoretically, price appreciation should feel the same. But the truth is that as humans, we feel different when a dividend cash payment lands in our account.
It’s also part of the reason income-seeking investors like those in retirement love income funds. Because they provide a feeling of getting a ‘regular paycheque’ which is known upfront.
I love it too. Who doesn’t?
Global Tracker and Dividend Funds / ETFs for UK Investors
Here is a list of global trackers and dividend funds.
|Vanguard FTSE All-World UCITS ETF (VWRL)||0.22%||Market leader. Developed and emerging markets.|
|iShares MSCI ACWI UCITS ETF (SSAC)||0.20%||Developed and emerging markets. Very decent tracker, MSCI All-World.|
|Vanguard FTSE Global All-Cap Index Fund||0.23%||Developed, emerging markets plus 5% allocation in smaller companies. An all-in-one fund with over 7,000 stocks.|
|SPDR MSCI World UCITS ETF (SWRD)||0.12%||Developed markets only.|
|HSBC MSCI World UCITS ETF (HMWO)||0.15%||Developed markets only.|
|iShares MSCI World Quality Dividend ESG UCITS ETF (WQDV)||0.38%||Up until 2022, this used to track the article’s dividend benchmark: The MSCI High Dividend Yield. But it now tracks an ESG Dividend equivalent with about 200 stocks.|
|Vanguard FTSE All-World High Dividend Yield UCITS ETF (VHYL)||0.29%||Tracking FTSE’s All-World dividend benchmark.|
|Xtrackers MSCI World ESG Screened UCITS ETF (XDWY)||0.19%||Another MSCI High Dividend tracker that changed its benchmark to the ESG equivalent.|
Some other popular dividend funds include:
- SPDR S&P Global Dividend Aristocrats UCITS ETF (GBDV)
- Fidelity Global Quality Income UCITS ETF (FGQD)
- Xtrackers STOXX Global Select Dividend 100 Swap UCITS ETF (XGSD)
- JPMorgan Global Growth & Income PLC (JGGI)
As you can see, there is no dividend fund that tracks the pure MSCI High Dividend Yield Index that my research focused on.
They now track the MSCI High Dividend Yield ESG Reduced Carbon Target Select Index (read their factsheet) with companies that satisfy certain ethical, social and governmental (ESG) characteristics. This is why only 200 or so companies make the index. The performance is only available since 2010 which is probably when the ESG index was created.
Its performance comes very close to the MSCI World and is almost identical to the MSCI High Dividend Yield Index.
Based on the above, it is a shame that there is no true passive “MSCI High Dividend Yield” ETF out there! It looks like ESG spoiled the party.
The ESG one comes very close, and another option is Vanguard’s VHYL.
Are dividend funds worth it?
You often hear that dividend trackers are suboptimal to broad equity trackers. This was true after 2008 but dividend funds performed much better pre-2008.
On top of that, UK limited companies have an advantage when investing in dividend funds, as the dividends are not subject to corporation tax.
There are certain advantages when choosing a dividend fund, such as Vanguard’s All-World High Dividend Yield (VHYL).
It is easier to hold because it pays you a decent income. In a changing rates environment, it might perform better too.
On the other hand, a broader global tracker such as Vanguard’s All-World ETF (VWRL) might be a better option, despite the worse tax treatment.
Personally, I am not changing my strategy despite the juicy dividend yields. But I won’t blame you if you will, especially with a smaller allocation. It doesn’t have to be all or nothing.
If you want to generate a high yield on your savings, check out the best places to hold cash in 2023 article. It contains high-yielding short-term government and corporate bond ETFs as well as money market funds.
Another option is to choose high-yielding UK REITs if you enjoy investing in property funds.
I hope you enjoyed this article and Happy Investing!