With intense volatility in the financial markets, the temptation to cash in investments or stay away from financial assets is very strong. At times like this, clear-headed thinking is needed.
A savings pot is essential in everyone’s life, especially important as your career and age progress. Early on, people focus on lifestyle and establishing a home, but, later, the value of building a pot upon which retirement, or an alternative life, can be funded comes in to sharp relief.
This is particularly true for those of you, like me, who have to depend on savings that are self-administered. Having your employer take care of retirement is predominantly not an option in a world in which defined contributions have replaced defined benefits.
Let’s assume that you are on the average industrial wage of about €40,000. You have broken the back of the mortgage, the children have grown up and left, leaving you with options for the future.
It is reasonable to think your annual income needs to be about €30,000 to fund a life akin to what you were used to when a large house loan and education costs were stripping the monthly pay check.
With a target of €30,000 per year, what type of savings pot do you think is required?
This is an intriguing question, given that low interest rates have become the new normal. Indeed, large, global central banks have moved into negative interest-rate territory as they grapple with tough global markets.
It has been a challenge, in such an environment, to construct a low-risk savings pot that produces an annual yield, or dividend, much above 2%.
Assume a 2% yield implies a savings fund of 50 times your targeted annual income. Our punter, who is targeting €30,000 per year, therefore needs no less than €1.5m to deliver an income without tapping his capital sum.
If there is any silver lining to the dark clouds that have enveloped world financial markets recently, it is the change in the dividend yields being made accessible to investors.
While yields of 2% or below were commonplace throughout 2015, that scenario has changed since and has produced a collection of companies that is offering higher dividend yields. This changes the hurdle rates set for the individual profiled above.
If, for example, we assume a savings pot can be built with a very low-risk profile offering dividends close to 5%, then the total sum needed to produce a €30,000 annual income falls dramatically, to €600,000, from €1.5m. This exemplifies the power of dividends and underlines their importance to long-term investors.
So, I would be on the hunt, now, for companies that have clearly identifiable, strong balance sheets, profits that comfortably cover the cost of their dividends, and management teams that are unequivocal advocates of the value that dividends provide to their shareholders.
These are the litmus tests that must be applied by anyone parting with their hard-earned income to help shape a portfolio that is highly conservative.
While these tests sound simple, they are incredibly hard to apply. You can find plenty of companies that have high headline dividend yields, often above 5%. However, a deep dive of their finances, track records, and management style often reveals a less-than-obvious record of dividend performance and management.
Some pay lip service to the concept, others have business models where profits oscillate viciously, and yet more have balance sheets with relatively high debt burdens that undermine their ability to convincingly fund steady and growing dividends.
In the sharp sell-off of equity markets since January 1, I have seen high-quality, global company shares decline quickly. Amid that general weakness, the dividend yields of companies that could well qualify for our example portfolio have started to creep up to levels that warrant closer inspection.
It is in the middle of these distressed markets that long-term investors have to keep a steady hand on the savings tiller.
* Joe Gill is director of corporate broking at Goodbody Stockbrokers. His views are personal.
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