A robust option
Shares that pay dividends are a popular option with Australian investors as they often provide a reliable source of return. This can provide a welcome cash injection or be used to reinvest for further growth.
Choosing to invest in companies that pay dividends can be an excellent way to build wealth as part of a long-term investment strategy.
Dividend paying shares are typically more resilient to market turbulence and share price fluctuation, plus they may receive attractive tax credits.
What are dividends?
A dividend is a portion of a company’s profit paid to shareholders in return for their investment.
Many companies listed on the ASX will elect to pay dividends twice a year. These are usually referred to as an ‘interim dividend’, paid halfway through the financial year and a ‘final dividend’, paid at the end of the financial year.
A dividend yield is the share’s dividend as a percentage of the share price.
Typically, a good dividend yield is one that is higher than the current interest rate.
A reliable return
Dividends are an important consideration when investing in the share market as they provide a reliable source of return. The payment of a dividend is much more dependable than an increase in capital growth in a given year.
Over the past twenty years, the ASX has generally delivered a return of around 9-10%, with half of this amount being delivered through dividends.
So, a share with a dividend yield of between 4-6% that also has potential for growth is attractive as it is already showing the capacity to deliver up to half the desired return through dividends alone.
Dividend payments are reliant on the company’s profitability, so they are not directly correlated to the share price. Even if the market has had a bad run, the board of directors can still choose to pay dividends. For example, during the Global Financial Crisis Commonwealth Bank of Australia shares fell in value by over 50%, however the dividend was only cut by 14%.
Valuable safety net
The dividend yield on shares can act as a safety net in times of market turbulence.
After a major market correction high dividend paying shares often recover faster than other securities as investors are attracted to the income they deliver.
Incorporating dividend shares into your investment portfolio can provide ballast during times of market volatility, providing you with peace of mind.
If a company has already paid tax on their profit, dividends may be distributed with a franking credit representing the amount of tax the company has already paid.
A franked dividend receives the tax credit that is paid to the shareholder by the Australian Tax Office.
The franking credit can then be offset against the investor’s personal income, or if the investor has no taxable income the franking credit is paid as cash. This is especially beneficial when shares are held in the pension environment where income is not taxable.
The Labor Party recently announced a proposal to abolish this cash rebate, a move that has the potential to seriously impact the income that retirees will receive in the future. You can read an overview of Labor’s proposed policy here.
In real terms, a franked dividend can deliver a financial gain in addition to the dividend yield. For example, if the dividend yield is 6%, the investor will receive 6% plus the offset in personal income tax or a cash rebate.
Are there risks?
Every investment comes with an element of risk and shares are no different.
Dividends are not fixed or guaranteed; they are paid at the discretion of the company’s board of directors and both the amount and frequency can fluctuate.
Not all companies will elect to pay dividends. Some may choose to reinvest their profits back into the company, or if the company has made a loss they will be unable to pay shareholders. For this reason it is important to have a good understanding of the company you are investing in and why a conversation with a financial adviser can be invaluable when considering your investment options.
Stable shares for the long term
Because dividend shares are resilient and may withstand market volatility, they are an important part of a long-term investment strategy. However, to achieve the best possible return it is important to have a strong understanding of the investment you are making.
At First Financial our clients can be reassured knowing the investments we recommend have been through a rigorous approval process. Our advisers draw from a pre-approved list of the highest quality investments that have been vetted by our unique Investment Committee made up of external consultants as well as in-house specialists.
When selecting investments, our advisers consider many factors including dividend yield to ensure the best options are selected for each client’s individual circumstances.
Source: Investors Mutual Limited, “20 lessons from 20 years of quality” www.iml.com.au/20-lessons