The hunt for dividend income in 2020
Written on the 4 February 2020 by Arrow
With interest rates at historic lows and likely to stay that way for some time, retirees and other investors who depend on income from their investments are on the lookout for a decent yield.
Income from all the usual sources, such as term deposits and other fixed interest investments, have slowed to trickle. Which is why many investors are turning to Australian shares for their reliable dividend income and relatively high dividend yields.
The average dividend yield on Australian shares was 5 per cent in 2019 and more than that for many popular stocks.
By comparison, returns from traditional income investments are failing to keep pace with Australia's low inflation rate of 1.7 per cent. Interest rates on term deposit from the big four banks are generally below 1.4 per centi, while the yield on Australian Government 10-year bonds is around 1.2 per centii.
But with shares entailing more risk than term deposits or bonds, is a dividend income strategy safe?
Dividends provide stability
Over the past 20 years, dividend income has added around 4 per cent on average to the total return from Australian shares.
For example, in 2019 the All Ords Index (which measures the share price gains or losses of Australia's top 500 listed companies) rose 19.1 per cent. When dividends were added, the total return was 24.1 per cent.
So how are dividend yields calculated?
Calculating dividend yields
Take the example of BHP Billiton. Its shares were trading at $37.41 in December after paying annual dividends of $1.9178, providing a dividend yield of 5.13 per cent ($1.9178 divided by $37.41). When you add franking credits, the 'grossed up' dividend yield is 7.32 per cent.iii
Franking credits are a type of tax credit compensating shareholders for tax the company has already paid. Companies such as BHP with fully franked shares will have franking credits equal to 30 per cent of the gross dividend value. This is not a recommendation for BHP, simply an illustration of how dividend yields are calculated.
But a big dividend yield is not always better. A high dividend yield may signal a company with limited growth prospects, a falling share price, or both. Sometimes it's the result of a one-off special dividend.
So how can you spot a quality dividend?
In the current low interest rate, low economic growth and low inflation environment, many companies have taken a cautious approach and rewarded shareholders with higher dividends. As growth picks up, companies may allocate a greater share of profits to growing their business.
Relying too heavily on dividends from Australian shares could also expose you to risk or mean missing out on opportunities elsewhere.
Consider the big picture
Diversification is also important across asset classes. The total return from Australian residential investment property was 6.3 per cent in 2019 (from a combination of price movements and rental yields), but in other years the performance of shares and property could be reversed.iv
And despite their lowly returns, holding term deposits with different maturity dates allows you to manage your cash flow. It also helps avoid having to sell your shares and crystallise losses in a market downturn.
If you would like to discuss your income needs within the context of your overall investment portfolio, give us a call.