Using dividends to provide a stable income

Low returns on savings accounts and time deposits may prompt investors to look for other ways to increase the return on their investments. One option is to purchase shares that pay good dividends.

USING SHARES FOR INCOME

When individuals look for investments that will give them a steady income, they often turn to time deposits or bonds. At this point, however, returns on both options are low.

Even the highest-yielding time deposits often offer interest rates of barely more than 1 per cent, while the average interest rate on Singapore Savings Bonds over the next 10 years is just over 2 per cent. Some corporate bonds or fixed income unit trusts do pay slightly more.

With consumer prices rising at 1.4 per cent annually, individuals are barely keeping up with their costs, and may even fall behind.

An alternative is to invest in shares that pay dividends. As investment adviser Blackrock explains, some dividend-paying stocks can deliver twice the yield of benchmark government bonds, while others offer the potential for capital growth and a rising income stream.

Dividend-paying stocks can thus be an attractive investment for various people, ranging from millennials who want to generate income over the longer term to retirees who want a source of income now.

The returns can be relatively good. Data released by the Securities Investors Association (Singapore) in April showed that Singapore’s biggest index stocks maintain the highest dividend yield among all the FTSE country indices in Asia, with an average yield of 3.7 per cent.

The FTSE index excludes real estate investment trusts (Reits), which can pay even more.

Along with the income from dividends, investors can receive capital gains if the price of the shares increases.

Historically, companies that consistently grow their dividends tend to outperform non-dividend stocks, which increases the benefits of investing in these shares.

Moreover, stocks that pay dividends may be less risky than other stocks and less vulnerable to steep declines because of the dividend.

As Blackrock also noted, income from dividends, rather than price appreciation, can be a significant driver of portfolio growth in this low-return world.

Reinvesting dividends rather than taking the dividends as income can be especially powerful, with data from Bloomberg going back to 1988 showing that the return on the MSCI Asia ex-Japan index nearly doubled when dividends are reinvested.

Those positive results do not mean that the income is guaranteed, of course, as share prices can also drop.

Investors who put money into Keppel Corp in 2014 when the share price was more than S$11 in order to get a high dividend, for example, have seen the share price fall to just over S$6 and annual dividends drop from 48 cents per share to 20 cents.

CHOOSING SHARES

Individuals investing in shares for their dividends will need to select them carefully so that they balance the potential returns with the risks of investing.

Simply picking shares which have the highest dividend yields is not a particularly challenging process, as investment advisory firm The Motley Fool observes.

However, investors need to look beyond the yield and consider the company’s financial performance as well as its rate of dividend growth.

Consistent payment of regularly rising dividends itself can be a positive indicator of company performance, as companies that pay consistently increasing dividends are often financially healthy firms that generate consistent cash flow, with share prices that tend to be less volatile than the market overall. 

It is also important to assess whether the dividend itself is safe. A key indicator is the payout ratio, which measures the total amount of dividends paid out as a percentage of the company’s profits and indicates whether the company can continue paying a dividend.

Companies that have a payout ratio above 100 per cent —which may seem surprising, but it happens — are paying out more in dividends than they earn, and may reduce the dividend if they face financial difficulties.

Investors should also diversify among a range of companies and sectors in case dividends from some firms are cut.

HOW TO INVEST

Investing in dividend-paying shares is straightforward. Investors can use online portals such as Investment Moats or other services to find companies with higher dividends, then analyse the quality of the firms as well as the safety of the dividend and purchase shares in companies they find acceptable.

Reits have historically used their income from property rentals to pay relatively high dividends, for instance, and a wide range of shares pay dividends that can deliver up to double-digit returns.

Investors who want an easier path towards a diversified portfolio of dividend-paying shares can invest in exchange-traded funds (ETFs) or unit trusts which focus on higher dividend yields.

The recently launched One Stoxx Asean Select Dividend Exchange ETF invests in dividend-paying companies across the region, for instance, while dividend-focused ETFs such as those run by Schwab or Vanguard in the United States can bring dividends from those markets.

MANY CHOICES FOR AN INCOME STREAM

In this low-yield environment, investors have a wide range of options to help them obtain a reliable source of income from their investments.

Carefully selecting local or foreign shares that pay dividends can deliver more income than some investors might expect.