Investing for Income
Fixed Interest Not Paying the Bills?
Many people that require income from their investments have their money invested in interest bearing securities such as cash or term deposits in the bank, corporate bonds or finance company debentures. As interest rates have fallen many people have taken a significant cut in income. An alternative source of income is dividends from shares.
The sharemarket has been considered by many as where you "make" money by buying shares with the expectation of selling them at a profit. This is speculating that carries with it the risk that the shares wont go up in price and you wont make a profit, or worse go down so you make a loss when you sell. Some share tippers and traders completely disregard dividends as a source of return. And quite frankly that's just stupid.
Have you considered investing in shares for income?
Most established companies pay out a portion of their profits as dividends to shareholders.
NB All figures below were current as at 9 September 2016, they will change.
The gross dividend yield on New Zealand shares is currently over 7%. The major trading banks are paying 4% or less for five year term deposits.
Some well known companies PGG Wrightson, Halenstein Glasson, Spark (used to be Telecom), Kathmandu, Methven, Heartland Bank were paying over 10% with forecasts of similiar dividends in the future.
At current yields shares are definitely worth considering as a source of income. But as always you must bear in mind the different risk profiles.
If you would like to discuss how to build a diversified portfolio of income generating shares please ring Jonathan or Andrew on 07 578 3863 for a no obligation chat, the first half hour is free so what have you got to lose?
Or if you don't want to pick your own selection of shares there are now tax efficient managed funds available where you pay the experts to do the work for you, and still get a return likely to be considerably hgher than what the banks will pay you.
Dividend Yield is the term used to determine how much return you are getting on an investment in shares.
If a company is paying fully imputed dividends of 7 cents per year and its shares are currently trading at a price of $1.00 the dividend yield on that share is 7% tax paid, recently this was the average dividend yield on the New Zealand sharemarket. Some companies pay more, others less. Your aim should be to continue to achieve at least whatever yield you invest at for the foreseeable future. Companies hate to reduce their dividends and will do almost anything to avoid doing so but you must do your homework. And it is extremely important to differentiate between historical and forecast yields.
Compare that to the less than 4% or so you will be get from investing in a five year term deposit with a bank which you'll have to pay tax on giving you a tax paid yield of only 2.8%. Yes, there is probably a higher risk but maybe the additional return makes it worthwhile?
Imagine that you are on a marginal tax rate of 30% and you'd like $1,000 a month income from your investments to top up your pension to live comfortably. So you need to earn $12,000 a year after tax.
$172,000 invested in shares yielding 7% will generate $12,000 in dividends. On the other hand, in order to earn $12,000 after tax at 4% you would have to invest nearly $430,000 in low risk fixed interest. You'd need two and a half times more money to generate the same amount of income from low risk fixed interest as you would from the right shares.
Put another way if you have $430,000 to invest you could currently earn income of $12,000 net per annum if you invest it all in low risk fixed interest, or $30,100 if you invest it all in the New Zealand share market.
Arguments Against Investing in Shares For Income:
Share Prices Might Go Down
This is the most commonly heard argument against investing in shares and the least relevant if you are investing for income. Yes, share prices might go down, in fact they probably will at some stage, but as long as you don't have to sell the shares and as long as the companies keep paying dividends it will make no difference to the level of income you receive. You don't have to sell shares just because the price has fallen!
That is worth repeating - You do not have to sell shares just because the price has fallen.
Companies Sometimes Go Bankrupt
Yes they do and that is why you shouldn't invest in only one company or industry and why you should be aware of what you are investing in. You don't put all you eggs in one basket.
I Don't Know Anything About Shares
Actually you probably do, you just don't realise it. Call us on 07 578 3863 or 0800 867 323 and ask to talk to an adviser who can explain to you how the sharemarket works in down to earth English. If the broker or adviser you are talking to can't explain it to you in language you understand try someone else. Also there are plenty of "beginners guides" and "how to" books written to help you, check out the selection at the Library and find a couple that appeal to you. But if you just don't get it, it's probably wise not to invest in something you don't understand.
Arguments For Investing in Shares For Income:
Companies Can Grow and So Can Dividends
As a company grows and generates more profits it will probably pay out more in dividends, so your income will increase without you doing anything. Even mature companies in stagnant markets or those that are already so dominant in their market that they can't grow by selling more are likely to increase profits over time simply by increasing prices to keep pace with inflation.
Tax Free Income
Dividends are paid out of profits that have already been taxed and so the amount paid to the shareholder is usually tax free. Indeed if you are on a marginal tax rate of less than 30% you can even get a tax credit. Most New Zealand companies pay fully imputed dividends, but there are exceptions and so you should check before investing.
It Costs Too Much to Buy Shares
When you buy or sell shares you will pay brokerage, back in the eighties it was as high as 2.5% of the value of the shares, now you shouldn't pay more than 1.5% and you may even get it cheaper. This is a one off cost and consider that you are spreading the cost over the period you are investing which should be many, many years. If you are investing for income you'll seldom want to sell your shares.
I Might Not Get All My Money Back
This is true, if you are forced to sell shares you may not get the same amount as you bought them for. The same is generally true of all securities. If you break a term deposit early the bank will charge you, if you invest in a company bond the market price will fluctuate and you may get less than you invested. However if you are invested in shares you might also get back more than you invested which is rare with fixed interest securities.
Most shares and certainly those you should consider for income generating purposes are traded daily and you can almost always sell them at market value and get your money out within three business days.
Should I Invest in the Sharemarket?
Perhaps in the past you've decided the sharemarket isn't for you. Maybe it's time to reconsider, given the current returns on offer. A diversified portfolio of shares could give you a running yield of 7% after tax. If you are getting that level of return elsewhere well done, but consider the level of risk you are taking to achieve it and how sustainable it is.
A diversified portfolio of shares can give you a reliable stream of income that is likely to at least keep pace with inflation thereby protecting the purchasing power of your income combined with the potential for your capital to increase in value over the long term. You simply don't get that from fixed interest securities alone.
If you would like to discuss how to build a diversified portfolio of income generating shares please ring Jonathan or Andrew on 07 578 3863 or 0800 867 323 for a no obligation chat, the first half hour is free so what have you got to lose?
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