14 Oct The role of dividends
When we invest in the share market we like to see our shares increase in value – obviously – but when the market isn’t performing well, instead of joining everyone in the doom and gloom: don’t forget about dividend income.
In Australia, unlike many other countries, we are fortunate that most of our companies pay an excellent rate of dividend. These usually include credits for tax paid by the company, referred to as “imputation” or “franking” credits.
As an example of the benefit, if you deposit your money in one of our major banks’ online savings accounts you will probably receive an interest rate of around 2-3% per annum. And these rates will follow the movement of interest rates. If you buy shares in that bank you are likely to receive a dividend in the region of 5-7% per annum. It is even better if the dividend is fully franked, as this would be equivalent to a pre-tax rate of 7-10% per annum.
And when a market downturn causes share market prices to fall, most companies continue to pay a steady dividend. The following chart shows the movement in Commonwealth Bank (CBA) shares since 2000, along with the dividends declared.
The dividends, as indicated by the blue area increase over time in a very consistent fashion, even despite the Global Financial Crisis (GFC) in 2007-2008.
Not all Australian shares are fully franked or have as high a yield as the example above. However, if you look at the average dividend yield for the All Ordinaries Index it is in the region of 4% with an average franking rate of 80%. This can give you a pre-tax return of around 5% per year.
The moral to this story is that your investment portfolio can fluctuate in value over time, however the dividends you receive for holding them can be far more reliable. As long as you don’t need access to your capital in the short term, generous dividend yields can fund a substantial part of your retirement income needs. For accumulators, dividends can be used to re-invest into the market – which in times of temporary falls can mean purchasing at discounted prices.
About Reuben Zelwer
Reuben Zelwer established Adapt Wealth Management in 2011 to help time poor clients achieve financial freedom. For over 15 years, Reuben has helped professionals, executives, business owner and those approaching retirement make the most of their circumstances by making good financial decisions. Reuben’s professional practice is complemented by substantial voluntary work, which has included setting up financial literacy and savings programs in the local community.