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The Times They Are A-Changing

FYI | Jul 17 2019

By Peter Switzer, Switzer Super Report

As we've had a few changes in the business lately, I've been joining a number of the progress meetings our financial planning clients have here at Switzer. I like to get to know as many of our clients as I can. And as there'd been a few changes, I wanted to get in and see how our financial advice clients were feeling.

I told this story below to those who subscribe to one of our weekend online publications, but in case you don't subscribe to that, I want to tell it to you here.

While the range of returns for our clients has been between 6% plus to over 11% (depending on the appetite for risk my clients have), one couple who have about $3 million in their super fund, only wound up with a 1.5% return!

I had to ask these delightful people: "Did you put my advisor/colleague in a headlock to go so conservative?"

The husband fessed up, admitting that despite the fact he reads my stuff daily, he really expected a big market sell off this year!

I must admit I understand why a retired couple with $3 million in super would want to protect that money. However, being too much of a scaredy cat actually creates more scary outcomes than many would expect.

I said to my clients that I want to create a portfolio of assets that should be able to deliver about 5%. And after franking credits are added in, that number could creep up to 7%.

That means if my clients had succumbed to Switzer rather than their own fear, their income for 2019/20 would have been $231,000 rather than $49,500! That's a big price to pay for being scared and very conservative.

After a bit of convincing, I was able to suggest to my clients that we could create a portfolio that would deliver 5% plus franking, but I also said you have to accept that your capital will go up and down. However, the pay off will be a reliable stream of income that even a GFC-type crash wouldn't reduce by much. The portfolio behind that income will be important and the more recession proof the business, the better.

Investors need to understand that with term deposit rates so low, they'll have to go up the risk curve to get their precious 5% or more.

I know 5% is seen as the ‘precious rate' for a term deposit. Even when that rate prevails, the inflation rate is probably 3% but retirees don't seem worried about that, even though they should be.

Because we're living longer, investors/retirees have to get used to the ups and downs of the stock market. If they load up on dividend-paying stocks plus franking credits, they can actually ‘bank' income that can add to their capital.

What do I mean by that?

Let's assume you have $1 million in your super fund and you can live on $50,000 a year. If your investment strategy consistently gets 5% plus 2% for franking credits, you're pocketing $70,000. That means you gain $20,000 a year over what you need. You can bank this extra return into a buffer account for the GFC-style times. This buffer can make up for when your dividend-income drops to say 3% for a year or 5% thanks to franking credits.

Over time, as my example shows, the averaging of dividends shows a pretty constant supply of income is possible, despite the kind of challenge that a GFC could deliver to stocks and the people who own them.

I often say this chart below is my favourite chart, when it comes to why I like stocks. It shows that $10,000 invested in stocks in 1970, would roll over (with the reinvestment of dividends) into $453,166 by 2009 — one year after the stock market collapsed 50% because of the GFC!  The portfolio involved would be like an exchange traded fund (ETF) for the S&P/ASX 200 index — our top 200 listed businesses, which would be more growth-oriented rather than income-delivering.

An ETF like this is expected to deliver 10% per annum over a decade, despite two or three years of absolute shockers for stocks. And half of these returns is tipped to be dividends. That's why I like the idea of stepping up your acquisition of stocks that are big dividend-payers.

You would get less capital growth upside in boom bull markets but you'd get a steady flow of reliable dividends plus franking credits.

This is a defensive strategy that could be a nice income provider for scaredy cat investors/retirees. But they'd have to learn to sleep when their capital cops it in a GFC-style crash. How could they do that? Well, that would come from their income reliably showing up year in, year out.

Of course, future history could surprise us but history as it now stands says my passion for dividends isn't a dumb strategy, provided you can learn to live with the ups and downs of the stock market. That said, have another look at the chart above. The blue line for Aussie stocks shows that despite those crashes, the uptrend resumes crash after crash after crash.

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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