Financial planning,  Investing

You don’t have to rely on dividends for income

Everybody loves a good dividend, but sometimes investors, especially those in retirement who face the prospect of living off their portfolio, become a little preoccupied with them and their objective becomes generating enough yield to live off while hoping to preserve their capital. That can be a mistake because it overlooks the importance of growth.

According to Class, more than half of all Australian self-managed super funds own Telstra shares and I’d bet London to a brick that almost all of those investors bought them, or at least hang on to them, for the yield. And how’s that worked out? Given Telstra shares are trading below where they were 10 years ago, not great.

Let’s compare them to a genuine growth stock, CSL. Through most of its listed life CSL’s shares have traded on a yield of less than 2%, so they wouldn’t have made it on to the radar of a yield-seeking retiree. But in fact, they would have been far better off buying CSL instead of Telstra.

Total return: income + growth

The table below shows the total return over 10 years from buying $100,000 worth of Telstra shares on 7 December 2007, including the all important dividends and franking credits, was $65,453, which works out to be 5.2% per annum. Over that 10 year period the dividends grew at only 1% per annum.

That compares to the total return from buying the same amount of CSL shares of $321,025 or 12.4% per annum. That’s a whopping five times the amount or a $255,000 difference and CSL’s dividends grew at 15% per annum.

Living off the dividend

What if you’d bought the Telstra shares back in 2007 thinking I’ll live off the 8.5% grossed-up dividend yield and just maintain my capital?

You can achieve the same outcome by just paying yourself a dividend every year by simply selling enough CSL shares each anniversary to cover the same living costs.

The table below shows how that would have worked out: presuming you sell enough CSL shares to make up the difference between the CSL dividends and what you would have received from the Telstra dividend each year.

After 10 years you are still $120,000 better off having invested your original $100,000 into CSL shares.

A stock’s dividend yield is only half its story. The other half is how much growth it offers, and sometimes that’s the most important part.

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