Cries for income
Across Australia, retirees are crying out for income. Regardless of how much they might have in super, retirees tend to have the same goal - to generate as much income as possible.
The argument underpinning this urge for income is simple - earning enough income to live off means you don’t have to touch your capital.
It’s a logical theory. You have squirreled cash away for many years and the thought of burning through your savings seems absurd and it’s certainly sensible to leave the lion’s share of your fund alone for as long as you can.
But the reality is most retirees will need to eventually spend some of their capital, as the amount we are all forced to withdraw from super rises as we get older. What’s more, you could be faced with higher expenses that come with increased medical costs.
Adding to the pressure to find a solid income stream is the current economic and financial environment. No less an authority than the Reserve Bank of Australia governor Glenn Stevens reckons those retiring today are in a worse position than those of a decade ago because the price of low risk assets, like bonds, have been pushed up.
A quick survey of those managing and living off their own super concludes that most prefer to invest in high-yielding Australian company shares. With an official cash rate at 2.25 per cent, it has wiped out the return from term deposits and other fixed income investments, forcing investors to chase shares for their dividends.
The appeal of dividend-payers
Historically, high dividend stocks have been perceived as immune from price declines, which to a degree, is a reasonable assumption. Companies that generally offer the best income are those that are considered defensive and do well even if the economy is faltering. And depending on the circumstances that trigger a price slide, investors are likely to step in and buy shares for the bumper yield on offer. This provides support for the shareprice, stemming further losses.
In addition, paying dividends indicates the company is already profitable. And there is the old adage ‘a bird in the hand is worth two in the bush’ - investors prefer greater certainty to less.
While there are traditional factors that support the share price of dividend-paying companies it’s no guarantee of shareprice certainty, especially when the Federal Reserve raises interest rates.
The relevance of the US central bank lies in the fact that when interest rates go up, bond prices sink - and not just in the US. The old aphorism about when the US sneezes the world catches a cold is still, to an extent, relevant in financial markets. And the relationship spills over to high dividend yield companies.
In other words, share prices of favourite defensive stocks are still susceptible to systematic risks that come from higher interest rates. When interest rates rise, financial, property trusts and utilities no longer as attractive because you can get a better income from other investments that are not considered as risky.
Do something different
But what if there was another way to invest your retirement savings where you could ride more comfortably through these shifting conditions? Indeed, there is. It involves investing some of your portfolio in companies or funds that focus on growing your capital, as opposed to just paying dividends.
The idea is as your capital increases in value, you will sell some of these gains down and use the gains to meet your income needs. (And yes it does mean selling capital - but your capital should be growing, not stable.) As a retiree, you should be in the pension phase of super (which is something you might want to consider if you aren’t), so you don’t incur any capital gains tax.
This strategy however doesn’t give you the same franking credits as investing in high dividend yielding companies, but depending on the shareprice growth, you might not even notice their absence.
Although we have explained there are two ways you could invest your retirement savings, they aren’t binary. You might employ a mix of the two. It’s easy to stick to what you know, but there is value in considering alternative ways to invest your savings that could protect you from rising interest rates, but still provide the same result.