The recent stock market slump has not only shrunk the value of investors’ portfolios, but also has led to dividend cuts by many blue chip companies.

This is a particular problem for those investors, many of them elderly, who depend on dividends to eke out their modest retirement incomes. If the payouts from their shares or funds are reduced, so is their standard of living. A dividend cut of 40 per cent (by no means unusual in today’s markets) would mean that someone receiving a dividend of £1,000 would have his or her payout reduced to only £600 — a dramatic loss of spending power.

The reductions in payouts will also come as a severe blow to the many savers who have switched money from deposit accounts to equities as low interest rates have pushed them to seek higher-yielding homes for their nest eggs. They now face a double whammy of a drop in dividend income and a fall in the capital value of their equity holdings.

So what is the scale of dividend cuts by companies and funds? In the first quarter of this year about 25 per cent of companies in the FTSE 350 index took the axe to their dividends. Among the companies that have announced lower payouts in recent months are household names such as BT and Marks & Spencer.

The biggest impact of all has been felt in the financial sector, says Rebecca O’Keefe, of Interactive Investor, the online stockbroker. She says: “Bank shares were at the heart of the credit crunch and have been savaged in the stock market downturn. Lloyds Banking Group, RBS, Barclays and Northern Rock have all stopped paying dividends, while HSBC has cut its dividend by 29 per cent.”

The implosion of bank stocks has been especially bad news for small private investors because they are heavily invested in the sector. This is because many of today’s banks, such as Lloyds, Barclays and Northern Rock, are wholly or partly made up of demutualised building societies and thus have a particularly strong base of private shareholders. This is particularly true of Lloyds, whose 2.8 million shareholders include a large number of former Halifax investors.

Ms O’Keefe says: “The extent to which income-seeking investors have been hit depends very much on the sectors of the market in which they were invested. Oil stocks and pharmaceutical stocks have held up very well, while blue chips such as Royal Dutch Shell, BP, GlaxoSmithKline and AstraZeneca have actually increased their dividends during the recent downturn. On the other hand, financials have cut their payouts heavily. Investors who were overexposed to the sector are now suffering sharp cuts to their income while those who diversified their holdings across different sectors should not be suffering too badly.”

So what should income-seeking share investors do now? In most cases, Ms O’Keefe says, they are likely to do better by sitting tight. “Those who have held bank shares all the way through the recent market turmoil should probably stay with them now. There is light at the end of the tunnel. Barclays expects to resume paying dividends at the end of this year, while Lloyds hopes to follow suit either this year or next, with RBS a bit behind. However, it is certainly worth diversifying your portfolio by gaining exposure to a wider range of stocks and sectors.”

Meanwhile, fund investors have been sharing the pain. Of the 75 UK equity income funds making dividend announcements since the start of the year — a hefty 36 per cent have reduced their payouts. In April alone 45 per cent of funds cut dividends. AXA Framlington sliced 42 per cent off payouts on its Monthly Income Fund while Lazards cut 43.7 per cent from the dividend on its UK Income Fund.

Brian Dennehy, of Dennehy Weller & Co, the independent financial adviser that produces a monthly online “Dividend Watch” bulletin, says that income seekers must keep close tabs on fund payouts because they can vary greatly. While the AXA Framlington and Lazards funds were pruning back their payouts, Neptune was increasing the dividend on its Quarterly Income Fund by 28 per cent.

He says: “You need to take a look under the bonnet and examine how your fund’s portfolio is made up and what the manager’s strategy is. For example, a sharp fall in dividend payouts could have been caused by the fund manager holding a heavy concentration of bank stocks. In other cases, such as with the Schroder Income Fund, managers have triggered a cut in payouts because they have switched part of the portfolio to chase capital growth rather than income. This may or may not improve the fund’s overall performance, but it is of little use to investors who need regular income. If you don’t like what you find, you should move your money.”

Mr Dennehy says that one option for income seekers is to switch out of a fund with an inconsistent record of payouts to another UK equity income fund with a more solid track record, such as Newton Higher Income. Another is to look farther afield and pick a global income fund. He says: “Asian companies are increasingly committed to dividend payouts. Where they have had to reduce dividends, they trim rather than cut severely, as happens in the UK.

“Diversification is always a good idea, both for funds and shares. The wider the spread of investments you have, the less danger there is of one poor choice blowing a hole in your expected level of income.”

Five income shares

BP — Oil company with a high level of reserves, strong profits and plenty of cash available. Yields 7.4 per cent.

GlaxoSmithKline — The big pharmaceuticals company has a number of drugs in the pipeline. Yields 5.3 per cent.

British American Tobacco — Increased profits last year in a tough climate. Yields 4.9 per cent.

Vodafone — Mobile phone group with strong profits and an attractive dividend. Yields 6.6 per cent.

Scottish and Southern Energy — A well-managed utility with a steady income stream. Yields 5.7 per cent.

Five income funds

Newton Higher Income — A track record of avoiding problems and growing payouts. Yields 7.1 per cent.

Threadneedle UK Monthly Income — Beacon of stability in a turbulent market. Yields 5.7 per cent.

Sarasin International Equity Income — Has boosted payouts in a tough market. Yields 5.1 per cent.

Standard Life UK Equity High Income — Solid track record of increasing dividend payouts. Yields 6.7 per cent.

Rathbone Income — Another fund with an excellent record of rising dividends. Yields 6.5 per cent.

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