Anyone investing in shares is taking some level of risk. Even more of a risk if that share is not paying a reasonable dividend, because you only have the speculative hope of a return, if the share increases in value.
So is receiving a dividend from an investment enough income for an investor to be earning, especially for a SMSF member that needs every dollar to live on.
A good company would pay up to 2 dividends each year. However, on average, companies only pay 1 dividend per year. In Australia, the average dividend yield is 5.5% while the cash rate is 3.5%. If you are receiving this income inside a SMSF that is in pension phase, or zero rated tax, the return is more likely to be 8% due to the return of the franking credit.
Dividends in themselves are less volatile than the price of the shares. Share prices ride many factors every day that may have no direct relation to the company performance, eg world market influence. Dividends are proportionate to the internal performance of the company only.
The true dividend yield is also a difficult one to determine as it’s always reported based on the current share price. What if you purchased the share when it was a much lower price than it is when the dividend is paid, then you would be yielding a much higher rate.
So what if you could receive up to 4 dividends each year? What kind of return would that look like over a financial year?
It’s called dividend stripping or as I prefer to call it dividend chasing.
It does involve a risk to the average investor so it’s not for the light hearted. It means buying the share prior to the share paying its dividend and then selling out to buy another company that is getting ready to declare its dividend.
The strategy works best if the share is purchased well before the dividend declaration as the share market usually rallies and the price is going up closer to the dividend date. Usually the share price will drop ex-dividend date but the bank stocks have shown a high resilience in the current market that they normally recover and a it is possible to still make a gain.
Basically, investors are also capitalising on the franking credits that can effectively be recovered on receiving such income. The SMSF investor in a zero rated tax position is in the best position of all.
There is however, a rule that must be adhered to if this strategy is going to work. The share must be owned for a minimum of 45 days plus the purchase and sale dates, so effectively 47 days, in order for the franking credits to be claimed back.
Why is it not for the light hearted? You need to know when to enter and when to exit because it is imperative to profitable trading. Choosing sound companies which historically increase the dividend distributions year after year is also a must. It is important that the price recovery from the dividend payment is strong as that is an integral part of ‘dividend stripping’.
You are best to get sound advice on this type of strategy should you want to implement this for your SMSF. Timing is everything for this strategy to work best and when to implement it for your superfund is also imperative.