Pessimism About Dividends & Australian Share Investment Needs To Be Contained
This morning I have read an interesting article written by Don Stammer for the Australian's Wealth section - Pessimism about dividends has gone too far. Unfortunately the web version does not include the graph but the commentary is still very useful.
The article looks at an issue that our firm has been in discussions with clients over the course of the last few months. That being turning the attention away from the gloomy pictures of depressed asset prices in growth asset classes and focusing on a key benefit from investing in shares - their dividends.
A lot has been written about the threat to dividends coming from the global economic downturn. This threat is real. We have seen during the current company reporting season that some companies are experiencing tougher times through falling profit levels and/or tougher financing arrangements. This causes them to reduce dividend payments either because they can no longer afford to keep paying them at the same level or they need to hold back more of their profits to use towards paying down debt and financing projects going forward.
The key question then is by how much might these dividends fall?
Why an answer to this question is important is in weighing up the income from alternative investments. In Stammer's article he states the current yields from investment classes if you were to start investing now:
Cash - 3%
Long term government bonds - 4.3%
Residential real estate - 4%
Australian shares - 7%
This Australian share yield is based on trailing dividend payments compared to current asset prices. This is not an accurate reflection of the likely future yields as future dividend pay outs seem likely to fall. Stammer suggests in the article that he sees them falling by 25% putting future yields at approximately 5.25%.
Even at this level of yield, investing in Australian shares appears attractive compared to the alternatives. For those investing through superannuation or pension modes this yield becomes even more attractive due to the franking credits received from the majority of Australian shares. The average level of franking in the ASX200 is around 80%. How does this impact the effective yield investors will receive?
In Super - a 5.25% yield, franked at 80% grosses up this yield to 7.05%. Paying 15% tax on this leaves you with a return of 5.99% after tax.
In Pension mode - a 5.25% yield grosses up to 7.05%. As you pay no tax on investment earnings in pension mode this equates to a 7.05% effective return.
Stammer also provides an interesting discussion and supporting chart that looks at the trailing dividend yield compared to current asset prices on the Australian share market. This graphs shows peaks and troughs. Currently we are in a peak period which suggests the current trailing dividend yield is higher than average levels. More evidence that dividend yields will fall. Interestingly, the average trailing dividend yield has been 4.1% since 1945. This is still attractive when taking into account marginal tax rates.
A table comparing the different yields mentioned in this blog at the different marginal tax rates follows:
Actual Income 0% tax / 15% tax / 30% tax / 40% tax / 45% tax
Cash 3% / 3% / 2.55% / 2.10% / 1.80% / 1.40%
Long Term Government Bonds 4.30% / 4.30% / 3.66% / 3.01% / 2.58% / 2.01%
Residential Property 4% / 4% / 3.40% / 2.80% / 2.40% / 1.87%
Australian Shares 5.25% / 7.05% / 5.99% / 4.94% / 4.23% / 3.88%
Australian Shares 4.10% / 5.51% / 4.68% / 3.85% / 3.30% / 3.03%
The comments from Don Stammer suggest that if you are focussed on the benefit that Australian shares provide - dividends - and can tune out from the difficulties around their current prices and have a long term investment horizon (i.e. more than 7 years) then purchasing new holdings of Australian shares in your investment portfolio, and keeping on to current holdings, seems to make sense.
As always, the final determinant should always be whether this makes sense in terms of your own personal circumstances and risk profile.
Bye for now,
Scott Keefer
www.acleardirection.com.au
Scott Keefer is the General Manager of A Clear Direction Financial Planning and has been a partner in the business since January 2007. He has completed a number of degrees related to financial management including a Masters of Financial Planning and Bachelor of Commerce. He also holds a Graduate Diploma of Education. Scott is currently a candidate in the Chartered Financial Analyst (CFA) program.
He is an Authorised Representative of FYG Planners Pty Ltd, Australian Financial Services License 224 543.
Prior to joining the business, Scott was involved in secondary education where he held middle management positions in schools in Brisbane and Jakarta, Indonesia. Part of these experiences involved teaching Indonesian students about Business Management and Economics principles as relate to the Australian context.
Scott is a co-author of the book 'It's Time You Knew the Truth: Building Investment Portfolios That Work' and ‘A Clear Direction - Your Guide to Being a Successful CEO of Your Life'. He has a passion to work with people at all stages of the financial planning process helping them to build successful financial solutions through well structured investment portfolios.
Article Source: ArticlesBase.com
