On the front page of the Australian newspaper on Friday 27th February, the story runs ANZ plans to SLASH (the media loves using words like these) dividends.  

Dividends are the profits that companies share with their part owners (shareholders).  For many, this is the reason for investing in shares, a steady and usally growing income stream with capital that grows about inflation.

Most investors were receiving around 3% to 5% pa of their capital back each year in dividends.  However over the last 18 months many shares have fallen by around 50% and investors have seen the capital value of their portfolios savaged – but what about the income?

Well for most this will be the first time in many years that they will also see a decrease in their income too.  But if you were looking to invest in shares today would the headline excite you or scare you off?  For most people they would be scared off but let’s see what this really means...

Let’s face it, we are in the midst of a pretty severe economic downturn and in tough financial times, companies need to make tough decisions, and if that means paying out less income so that the company can continue to operate profitably then it would negligent not to.  So what does that mean for an investor today?  If the price of an investment halves and the income only drops by 25% wouldn’t that make it twice as good as what it was?

For illustration purposes I am going to simplify the numbers.  If 12 months ago a share cost $1 and you received 4 cents return for every share your return would have been 4% (4/100) x100. 

But today with the share price being 50 cents (50% less – which many have) and we SLASHED the 4 cent dividend by 25% the dividend would now be 3 cents.

So if you bought a share that cost 50 cents and received 3 cents you would be getting a 6% return on your money (3/50) x100. 

So which is the better investment, getting a 6% return with the potential for your capital to grow over the long term so that it will keep up with inflation or the perceived safety of 4% (and still dropping)of a term deposit with no possibility for your money to grow?

 It is up to you to decide, but is important that you understand what the headline means because it might excite you to know.  

Reine – Senior Financial Planner