Recent headlines:

Effective yields from shares looks compelling compared to cash

Posted by Scott Keefer on Feb 17th, 2009

Last week’s interest rate cute by the Reserve Bank of Australia has made investment choices that little bit more difficult for investors. When the cash rate was sitting above 7%, investors holding cash were feeling pretty good about this especially considering the carnage on share markets around the world.

As these interest rates have been quickly driven downwards, the option to sit tight holding cash is not such an easy position to find yourself in.

One alternative might be to look more seriously at Australian shares. As of Wednesday last week, the yield (dividend income) on the ASX200 was 6.8%. If we assume that this yield is approximately 80% franked as per market averages, the effective income return for investors would be:

Marginal Tax Rate	Income from shares after tax	Income from cash after tax	Difference
0%	9.13%	3.25%	5.88%
15%	7.76%	2.76%	5.00%
30%	6.39%	2.28%	4.12%
40%	5.48%	1.95%	3.53%

# – not including Medicare Levy

The big question is how much companies might cut their dividends as a response to falling earnings and or to shore up funding requirements by holding back more of their profits from shareholders.

The profit reporting season has started to provide some guidance on this matter. A number of companies have reported significant cuts to future dividend payments while others have actually continued to increase dividends per share.

An average cut I have seen reported by analysts is around a 20% cut in dividends. How does this change the comparison table?

Marginal Tax Rate	Income from shares after tax	Income from cash after tax	Difference
0%	7.31%	3.25%	4.06%
15%	6.21%	2.76%	3.45%
30%	5.11%	2.28%	2.84%
40%	4.38%	1.95%	2.43%

Still a significant premium!

In fact, it would take dividend cuts of 64% across the ASX200 to see effective dividend yields match cash returns. This seems highly unlikely based on the current reporting by companies. It also does not take into account that cash rates may fall further in future months.

Unfortunately the decision is still not cut and dried as there are clear risks involved with investing in shares going forward. They have lost something like 40% in value since November 2007. This is because they are a risky investment. Before jumping in boots and all investors will need to weigh up how comfortable they are taking on extra risk in their portfolio.

One thing that investors can be certain of is that they would be buying shares 40% of their highs!

Regards,

Scott Keefer
www.acleardirection.com.au