Cows wander around paddocks, enjoying the grass. Cows have good times and bad times. Sometimes the grass is green, but other times the grass can’t be seen! Regardless of which paddock they are in, they are called in twice daily for milking, and bless their little cotton socks, they reliably produce milk albeit the volumes may fluctuate.
Likewise, shares can go up, down and sideways. They have good times and bad. Shares that pay dividends deliver yields twice a year regardless of how the shares have performed, however it should be noted that the dividend amount is directly linked to the company’s performance.
For this reason, we like to use the shares/cows analogy when we establish a share portfolio for our clients nearing or in retirement phase. A portfolio consisting of, let’s say, dividend paying bluechip shares selected from the ASX 200 means that year in year out, those shares will be producing regular and reliable payments. This can be a good strategy for retirees looking for a regular income stream.
A dividend is basically a distribution of profits paid by a company to its shareholders. The company determines whether to re-invest back into the business, or distribute some, all or none of the profit or surplus to its shareholders.
Shares that pay dividends pay out in two ways. Firstly there’s the dividend payments received twice a year as income, and secondly over time the shares capital value can also increase. A capital gain is where the difference between the original purchase price and the price you ultimately sell it for has increased. It’s important to note however, that the capital value can also decrease in value resulting in a capital loss.
The cream on top, pardon the pun, is the franking credits that often go hand in hand with dividend payments.
Franking credits are designed to stop company profits being taxed twice. The tax that companies pay on their profits can be passed on to their shareholders as a tax credit which is factored into the dividend payment. This can subsequently be used to offset the tax payable on the investor’s assessable income.
(Image courtesy of http://www.memecenter.com/)