Income Investing 101
Many retirees open a bank account for dividends. Every stock they buy they do the paperwork directing the share registry to pay any dividends into that bank account. Non-retiree investors, as well as some of the wealthier retiree investors, will elect instead to have the registry use the dividend to buy more shares under the Dividend Reinvestment Plan if there is one.
For those that rely on income the formula goes like this:
Assume a 4.5% yield from the stock market - this is your justification, a factual table of the capital and dividend returns from the All Ordinaries index over the last 40 years.
As you can see the average contribution to the All Ordinaries total return from compounded dividends before franking is about 4.5% over any time period in the last 40 years. A cursory calculation of the average franking in the Australian market weighted by market cap (complex and inaccurate guess) suggests that average franking is 72%. If that’s the case then you could say that the total return on average of compounded dividends from the All Ordinaries including franking is 5.89%.
But the conservative retiree will use 4.5% because the extra 1.39% usually comes as a franking credit refund (assuming you are in a tax-free environment in retirement) and rather than rely on that they will use that lump sum once a year refund for a holiday, renovating the bathroom or buying a car. It is not part of the spending arrangement.
Assuming 4.5%, if a retiree wants to earn $100,000 a year in income from shares, they will need $2,222,222 invested in the All Ordinaries. And this is a standard income expectation, $100,000 a year. Wealthy retirees will be living off $200,000 a year. If you have enough capital to earn $200,000 a year in income without eating into the capital base, you are very well off relative to a lot of retirees.
So the game is to build a couple of million dollars, invested in the equity market, and live off $100,000 a year. A lot of the clients we see are much wealthier than that and as the wealth increases their cash holdings and investments in things like hybrids and fixed income increase. One portfolio we did this week for instance was worth $8 million with the asset allocation split a third a third a third in equities, an investment property/business, and cash equivalents - and with that level of wealth the equities were focused on growth rather than income.
But let’s take the base case of $2 million invested in equities earning 4.5%. Why in equities? Because the returns on term deposits, fixed interest and other risk-free assets is now around 1% which means you would only be earning $20,000 a year. The next best source of income is hybrids. They yield 3.5% to 4.5% with a lot less volatility than equities and that might be your choice - for more about that CLICK HERE to read our recent article in hybrids.
But for most investors hybrids have almost no chance of a capital gain and on that basis they invest in equities instead where, as you can see from the table above, you can earn another 5% (being conservative) and capital gains, in which case your capital base will not only earn your living but it will grow at the same time. This is the equities Nirvana everybody is trying to achieve and if you can start this process with a little bit of smarty-pants timing (buying after a correction) you could do a lot better in the long term.
So let’s say you have $2 million only to invest, you have decided to put it in equities, and you are looking for stocks that you don’t have to worry about, you can hold in the long-term, are pretty low risk (no Mid-Cap growth stocks), will deliver $100,000 a year into that “dividend bank account” and hopefully also deliver that 5% plus capital gain that the equity market has delivered over decades. Now the question is which stocks?
THE DIVIDEND YEAR
To answer that question let me introduce the Marcus Today Dividend Year Calendar.
There is an established pattern of dividend payouts from the equity market during the year. Most companies, particularly the large companies, tend to go ex-dividend and pay their dividends on the same day of the same week every year (the financial weeks are numbered so they will pay on the same day of the same numbered week each year).
Shareholders like this certainty and the companies oblige. Not the case with a lot of small companies who don’t even know when the results are going to be ready, but by and large, at the big end of the market, company ex-dividend dates and pay dates are predictable.
Because the dividend ex and pay dates are reliable year in and year out we have mapped out for you the dividend year calendar. As you will see below there are periods of the year which see a lot of companies paying dividends, particularly in February and March and in August and September over the results season, and there are other periods which are “dividend dead zones”.
To help you identify those I have developed this:
THE DIVIDEND YEAR CALENDAR
- We have used the 2018/2019 Financial Year as the basis for the calendar. It will be the same this year with the dates moving by a day or two. The actual ex-dividend dates for this year are in the newsletter on the Extras tab. We have used the financial year rather than the calendar year because this is how most retirees/financial planners work, trying to achieve an income in a financial year and more importantly trying to achieve a franking credit refund for the financial year.
- We have broken the year up by PAY DATE - not ex-dividend date. The ex-dividend dates are shown but for retirees they are interested in when the money lands in the bank account not when the stock goes ex-dividend. The focus is on that “dividend bank account” remember. So each month shows the stocks that pay their dividends that month.
- In order to shorten the list we have cut out any companies with a market capitalisation below $1 billion. There may still be some income stocks with smaller market capitalisations, but for the conservative retiree, bigger is safer.
- The yields shown are a guide only, the column on the right shows the yield from that single dividend using the share price on the pay date. This is a rather arbitrary share price to pick for the yield calculation, but it has effectively enough thinned out the stocks into higher-yielding stocks.
- We have excluded any stock that yielded less than 2% on that one dividend. So give or take, the companies mentioned will be yielding at least 4% and those yielding less than that are not shown.
- Filtering by market and yield has reduced the list to 245 dividends a year cut down from the 790 dividend payouts last financial year.
- I have highlighted some of the more commonly held large income stocks, stocks that are not too volatile, although I have highlighted BHP and RIO which you wouldn’t naturally invest in for a sleep at night income. In the highlights are stocks like infrastructure, utilities, banks, Telstra, Macquarie, ASX and anything else that tickles my fancy.
- I have not highlighted the REITs but could have done. You will notice they and many of the infrastructure and utility stocks all pay at the end of August and the end of February having gone ex-dividend before the end of June and the end of December.
- Special Dividends - The tables include special dividends but by definition these are properly not repeatable/reliable.
Let’s start at the beginning of the financial year:
This was interesting that WBC started paying its dividend in June last year instead of July like the other banks. That may have been because they were trying to avoid Bill Shorten’s threat to stop the franking credit refunds so they thought they would do their shareholders a favour and pay before the end of the financial year. They may change this back again now the threat has gone.
DIVIDEND REINVESTMENT PLANS
This is a table of All Ordinaries companies that have a Dividend Reinvestment Plan showing the highest yielding dividend payouts at the top - not something retiree investors who want income would elect to do but those not relying on income would and in so doing create a compounding return on their shares:
HYBRIDS DIVIDEND CALENDAR
In order of pay date:
JANUARY TO JUNE
JUNE TO DECEMBER