- Published on 10 Jun 2015
- - Investment & Financial Advice
As investment advisers, yield plays a strong role in achieving client desired financial outcomes.
Investment yield refers to the income received from the investment, that should take into account actual cash return, as well as refunded tax (franking) credits where applicable, and should probably allow for expenses associated in generating the income return.
We are currently living in an investment environment where yields are depressed, and in many cases at historical lows.
This makes life difficult for retirees and other investors in attempting to achieve a certain cash flow outcome to meet their living or lifestyle expenses. With yields so low, investors are now being compromised and will as a result need to take on more investment risk to achieve their desired financial result.
We may think times are tough here in Australia, where cash rates are 2%, long term government bond yields at 2.5%, term deposits 3% at-best, but if you were to reside in Europe or the US, the yield conundrum is even more dire. Some investors are actually paying their bank to hold/invest money just to achieve greater capital security.
The Yield issue is also a problem in residential investment properties, where the likes of Melbourne and Sydney property values are riding high, at the expense of rental yields, which are hovering around 3%. And when taking into account rental and other property costs, yields as low as 2% (after-costs) are being received.
So, given the investment environment we are faced with, and given the Reserve Bank of Australia and other central banks around the world will take some time before cash rates will go up. Where do you turn to, to obtain a stronger cash flow result?
Everything in the investment world has a risk/return equation, you want higher returns, you need to take on higher risk, and so it comes down to making calculated risks when making prudent investment decisions.
What we know is that cash rates aren’t moving up for some time. We also know that if bond yields start rising, government bond valuations will come under pressure, so too the relative attractiveness of shares. We know that rental income (for property investors) will only increase if people can afford them to – relying on wage pay rises and job security (which isn’t currently the employment situation). And we also know that international shares (while good growth diversifiers) are not great dividend payers and so Australian shares seem to continue to be the superior dividend outcome for share investors.
There seems to be value in the ASX listed corporate debt security space (otherwise known as hybrids or convertible preference shares) at present, where grossed-up yields of 5.5%-6% are available, whose prices/values should be devalued by rising yields (unlike government debt) and where additional regulation on the banks will make them a less risky proposition from a credit-risk viewpoint.
Then moving up the risk spectrum, we turn to high yielding ASX listed (fully paid ordinary) shares, where there are businesses paying out 70-100% of their profits/earnings in dividends, and when taking into account their franking (amount of company tax paid), can provide a gross yield of 7%-9% per annum.
Portfolio risk management 101 says that in constructing a suitable portfolio of higher dividend yielding investments, you should diversify across companies and sectors to ensure than no one investment will derail the expected financial outcome. And this is a theory we agree with in this environment where banks and other businesses are still paying strong dividends, but whose earnings are softening. So ultimately those businesses that can sustain strong and increasing dividends will be sought after in months and years to come.
In summary, many mum and dad investors may ultimately settle for 2% cash returns or 2.5% term deposit rates because their investment risk comfort levels dictate complete capital security, however by expanding your investment horizons there is a world of opportunity and higher income returns, that don’t require that much additional risk or discomfort. And importantly it is these higher income returns that we expect to more than compensate you for their associated risks in the current low yielding environment.