Mining or oil? Tech or tobacco? 3 things to consider when choosing shares for a SIPP keeps showing up in conversations for a reason. The story below covers what is actually happening, where the trade-offs sit, and what a careful reader should take from it.
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A Self-Invested Personal Pension (SIPP) can provide a platform for long-term investment.
But while many people talk about investing for the long term, how they think about investing does not necessarily make the most of that timeframe.
Here are three things I think it makes sense for an investor to consider when deciding what shares to buy for their SIPP.
1. Identifying cyclical opportunities – and what that means for timing
Oil companies like BP and Shell operate in a cyclical industry. So, too, do miners like Rio Tinto.
A cyclical industry is one where high demand pushes prices up, typically bringing more supply online. That, perhaps combined with falling demand, leads to a glut in the market, pushing prices down.
Just think about the oil price and how much it moves around as an example.
The length of such cycles varies. But the key thing from an investing perspective is first to know that a given industry demonstrates cyclical characteristics – and then decide what is the right part of the cycle to invest in.
Timing the market is impossible, in my view. But it is sometimes possible to recognize that a given industry is at the higher end of its cycle – or its lower end.
Buying shares in cyclical industries can be lucrative, but it typically helps to buy near the bottom of the cycle, not the top.
2. Looking at the source of income
A lot of SIPP investors like the idea of piling dividends up inside their SIPP, possibly also compounding them over the course of decades.
But that raises the question: how long will a given company (or industry) throw off the sorts of dividends it does now?
Take tobacco, for example. Imperial Brands (LSE: IMB), like its competitors, is a generous dividend payer. Its current dividend yield of 6% is not far off twice the FTSE 100 average of 3.3%.
The company did cut its dividend in 2020, but that came after years of strong increases. So there was a question of sustainability. But despite that cut – and more modest increases since – there is still a question of sustainability.
The tobacco industry remains heavily dependent on the cash cow of cigarettes. Imperial is even more exposed in that regard than some rival cigarette makers, I reckon, as it has pushed less ambitiously into non-cigarette products.
But with the number of smokers declining in many markets year after year, how long can such a model last? Imperial has pricing power thanks to its brand portfolio and the addictive nature of cigarettes. But when looking at high-yield shares for a SIPP (or any dividend share, come to that), I think it is important for an investor to pay close attention to the source of dividends and their likely sustainability.
3. On the hunt for businesses, not just business areas
A SIPP can also provide a platform for long-term investing in growth shares.
When that works it can work spectacularly well. Nvidia is but one recent example.
But one mistake some investors make is zooming in on a growth area they think will do well in coming years, without then taking time to differentiate between the companies in that area.
Even in a business area that grows exponentially, there can be big winners and big losers.
