Explosive Returns…Income…or Both?

We can all make money in the market…sometimes. The trouble is making money consistently.

Paraphrasing Warren Buffett, the market is a voting machine in the short term and a weighing machine over the long term.

This basically means any stock can go up and down in the short term. But, over time, the market favours stocks that grow earnings and cash flow.

How long is ‘over time’? After all, it can get pretty boring waiting for your holdings to grow. What if you don’t have the luxury of time? What if you need cash now?

This can be particularly important if you’re on the verge of retirement.

If you’re close to retirement age, or already retired, investing with long-term capital gains in mind probably isn’t ideal. You may want some regular ‘bonus’ cash to pay for some extras and enjoy your life.

The average super balance for 60- to 64-year-olds in 2013/14 was around $215,332.

Assuming your super balance compounded 5% each year for the next 20 years while you withdraw income for life expenses, you’d be looking at $828 per fortnight in the first year and $435 per fortnight in the 20th year.

Hardly much to live on.

If we add the full age pension for couples to this figure, your fortnightly income climbs to $2,167 per fortnight in the first year and $1,774 in the last.

While it’s an improvement, not all of us will qualify for the age pension.

From July 2017, you’ll likely need to be over 67 years old, earn under $164 per fortnight, and have limited assets to receive the full age pension.

But even if you could meet this criteria, I’ll bet you’d like more than $46,000–56,000 a year to live on. So how can you grow your nest egg while also generating an income?

Your income asset class of choice

If you think about income-generating assets, what comes to mind? Real estate? Bonds? Stocks? You can generate an income from all three. But which is the best?

I believe the best choice is the one you feel most comfortable with. We are talking about your life savings here. You shouldn’t invest money into something you are unsure of.

For my parents, their asset of choice is real estate. They have almost nothing in super. Instead, they’re going to live off rental income when they finally stop working.

For others it might be bonds. AAA bonds are the highest quality bonds, with a relatively low risk of default. Although you can sell them in the secondary market for possible capital gains (or losses), there is no requirement to. You only need to hold on, collect the coupon (interest) payments, and cash in for the full amount you purchased the bond for on maturity. The date of maturity can vary from one year to 20 years…or longer.

Stocks are probably the least thought about when it comes to income. But investing in dividend-paying stocks can be a great way to grow your wealth and generate a regular income stream.

Let me explain.

Why stocks are better

If you’re already in retirement, new real estate investments probably aren’t for you. First, capital city houses already cost a pretty penny. That’s not to say they won’t continue to march higher from here…but they may not. What’s important to realise, looking for income, is that your rental returns at these prices are far from stellar.

Last year, average rental yields in Melbourne, for example, were only 3%. And that doesn’t take into account any maintenance fees you may be liable for as the landlord.

If you’re heading into retirement, the last thing you want to do is take on more debt. Time is the real estate investor’s friend. Not just because property can appreciate over time, but because you have time to pay down debt.

Bonds and term deposits might also not be the best option. While they’re fairly low risk, in our low interest rate environment, you’re not getting the best bang for your buck. As a holder of an Australian 10-year bond, you’d make a little less than 3% on your investment.

Similarly, if you had put your money into a term deposit, your returns would be far from satisfactory.

As reported by The Australian Financial Review:

…in 2008 an investor who retired with $1 million could have received a risk-free income of over $80,000 just from investing their portfolio in term deposits, enough to cover a comfortable existence without risking their nest egg.

But that same strategy would now give someone just over $15,000, way below the poverty line of $25,896, as calculated by the Melbourne Institute.

It’s a major reason why, when it comes to superannuation, investors need to think about income when they start investing.

So, what makes stocks so great?

For one, the yield on dividend stocks is generally far better than you’ll get on AAA-rated bonds. Second, while collecting dividends, your shareholdings can grow significantly higher than they would in the property market.

Let’s use an example.

Having your cake and eating it too

Let’s say that, five years ago, you found out airline travel and the retail sector were growing industries you wanted to invest in. You then dug a little further and, in each industry, found two businesses you thought had bright prospects.

Those businesses were Webjet Ltd [ASX:WEB] and Harvey Norman Holdings [ASX:HVN].

Over the last five years, you would have collected an average annual dividend yield of 5.28% on WEB and 6.98% on HVN. Over the same period, the yield you likely would have made on a 10-year government bond was 2.65%. And according to SQM Research, average rental yields for Sydney or Melbourne never broke above 5%.

But this is just the income portion. What about capital gains?

Well, over the same five years, WEB returned 346.77% and HVN returned 186.77% to shareholders. These investments individually beat median property price growth in Sydney (85%) and Melbourne (66.4%).

Now, it’s not always this easy to create an income and grow your wealth through stocks. With the benefit of hindsight, I chose two great stocks to make my point.

Had you bought BHP Billiton Ltd [ASX:BHP] and Woolworths Ltd [ASX:WOW] instead of WEB and HVN, not only would you have lost 33.38% of your investment, your dividend payments from both companies would be all over the shop, too. Not ideal if you’re counting on regular payments.

The best way to reduce your risk, and increase your chances of picking up the next WEB and HVN, is to read…a lot. Annual reports, letters to shareholders, and industry forecasts. You need to research and analyse which businesses you believe will have a prosperous future.

But with work and family, who has hours each week to analyse stocks? You might not, but income specialist Matt Hibbard does.

In his advisory service, Total Income, Matt spending hours each day digging through the market to find the very best dividend stocks with great future prospects. Stocks that can deliver strong capital gains, all while paying you a handy regular income.

To find out more, click here.

Until next week,

Härje Ronngard,
For Markets & Money

Harje Ronngard is a Junior Analyst at Markets and Money. With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation. It’s not good enough to be right on average when it comes to investing. The market is volatile and it only takes one bad day to ruin your portfolio. You don’t want to end up like the six foot man that drowned in the river that was five foot deep on average. It’s why Harje is constantly reminding investors of their downside risk here at Markets and Money. He does so by simply asking just two questions.  What is it worth? And how much does it cost? These two questions alone open up a world of investment opportunities which Harje shares with Markets and Money readers. Right now Harje is focused on managing research and investments over at the Legacy Portfolio. An investment publication designed to significantly grow investor’s wealth over time with deeply undervalued businesses. Harje also contributes his insights in Total Income, headed by income specialist Matt Hibbard. Harje loves cash-rich businesses, so he feels right at home amongst Matt’s high yielding income plays.

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