Do You Need An Alternative To Term Deposits?

FYI | Jun 26 2019

By Peter Switzer, Switzer Super Report

Do you need an alternative strategy to term deposits? Could it be stocks?

At a time when interest rates are on the way down, those who want to invest for income are scratching their heads on how they can get the 5% plus annual yield that most of us would be happy with. Of course, we'd all want 8-10% a year but that's easier said than done, so a 5-7% result, probably helped by franking credits, is a more likely outcome.

Clearly, with term deposits averaging around 2%, too much commitment to these brings down your overall return pretty aggressively. This means we have to look to other assets to help deliver the number we need to make our super funds deliver the lifestyle we desire.

I think it's through dividend-paying stocks that we can shore up our income from our investments.

Anyone wanting to swing more of their portfolio towards income-delivering stocks might look at the work done by the team at IG Markets back in April, who looked for the best big cap high-yield stocks. I've listed these below:

Note those yields could be slightly lower if the share prices of these companies have gone up since April. Most have but the projected and historical yields are still worth knowing if you want to build up your income via shares. NAB has also cut its dividend since this was published, so today it's yielding around 6.1%.

I've always argued that retirees really should have a portfolio of assets that deliver reliable income and being worried about your capital going down might be false economy, if you're too conservative and miss out on the growth when stock markets head higher.

The S&P/ASX 200 November 1992-today

Source: au.finance.yahoo.com

The upward slope in this chart shows how the stock market delivers. The starting point here was November 1992 when the Index was at 1456, meaning the capital growth was 356% over 27 years, implying an average gain of 13% a year, which is a compelling reason to like stocks.

As history says our stock market gains 10% per annum over a decade, with 5% coming from dividends, part of the extra gain since 1992 would have come from franking credits.

Anyone not needing to shoot the lights out with their investments should have a reasonable exposure to stocks and given the terrible term deposit rates, a 50/50 or even a 60/40 exposure for stocks to other assets might be justified, as long as you can sleep if your capital drops by 30% in a huge stock market crash. (This is not financial advice but financial education that you might like to think about.)

Stock prices in crashes plummet, but provided you have 15-20 holdings, dividends tend to get trimmed. Some companies might cut drastically but most trim. And that's why I've always leaned towards dividend-paying stocks for our clients, who want exposure to direct stocks.

Away from local stocks, there are good dividend payers overseas. IG Markets again says BP pays a yield of 5.79%, Marks & Spencer 5.96% and GlaxoSmithKline pays a whopping 6.14%. These were as of April 2019.

In the US, Altria (basically the old Philip Morris) pays 6.1%, Invesco 6.2% and Ford 6.8%! These were calculated in March 2019.

Away from stocks, the US corporate bond fund manager Neuman Bergman, which has about $US300 billion under management (and lends to around 300 companies in its fund, implying good diversification) has been a steady performer. Listed on the local market nowadays, after more than a decade working with some big institutions locally, this high-yield global corporate income trust, with a ticker code of NBI, could be an alternative to consider. It aims to pay a monthly income of 5.25% pa. Of course, it is more risky than term deposits.

For something more local, hybrids are and will remain popular, even if the cash rate goes as low as 0.75%, as many economists are predicting nowadays, from its current 1.25% level.

I know it's aggressive to hold, say, a 60/40 ratio of stocks to other assets but if that 60% is in historically good dividend payers, then the real riskiness of an 60/40 split is actually less risky than you think.

That said, when a crash comes, you have to be able to sleep at night knowing that your capital will make a comeback eventually and grow higher, though it can be slow, as we've seen since the GFC. But as long as the dividends keep coming through, it might actually be a better investment strategy.

Why?

If you started with $1million and cop a low 4% return by being too safe, then your nest egg rolls over to $1,480,244 after 10 years. However, if you use a heavily dividend-oriented strategy, pocketing say 7% with franking, your nest egg explodes to $1,967,151.

A 4% return on $1,480,244 gives you annual income of $59,209, while the 7% on $1,967,151 gives you $137,700 a year. And even if this dropped to a 4% yield during a GFC-style crash, the annual income would be $78,686, which is miles better than $59,209.

I guess it's a case of ‘no guts, no glory' when it comes to income.

Peter Switzer is the founder and publisher of the Switzer Super Report, a newsletter and website that offers advice, information and education to help you grow your DIY super.

Content included in this article is not by association the view of FNArena (see our disclaimer).

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual's objectives, financial situation and needs and, if necessary, seek appropriate professional advice.

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