Dividend Investing – A Perfect Fit For Aussie Early Retirees?

Dividend Investing

Regular readers will be aware of my love for dividend investing.

There’s nothing quite like making an investment, and in return, receiving an increasing sum of cash deposited straight into your bank account.  No hassles.  No bills.  And very little paperwork.  But it gets even better!

I believe dividend investing is a perfect fit for those of us aiming for early retirement.  This is especially true in Australia!  And today I’ll show you why.

 

Dividend Investing Doubts

Since I’ve started sharing my thoughts on investment openly, I’ve come across some folks who disagree with my approach.  And that’s perfectly OK.  In fact, it’s kinda good.  Often, we learn the most from the people who disagree with us!

Anyway, I want to delve deeper into why I prefer dividend investing over other retirement income strategies.  And clear up some issues I come across when people question it’s legitimacy.

When I first came out with this article, there were some concerns over my approach.  Namely, the figures I used for dividend returns and whether those numbers are sustainable.

To be clear, I was trying to highlight the advantage of dividend investing in Australia (partly due to franking credits), and how much income can be produced by investing in Aussie shares – using dividend yields at that time.

I wasn’t saying you should rely on a 6% ‘withdrawal’ rate.  I was saying that I think you can live off the dividend income from your portfolio (whatever that may be), while keeping some cash aside to smooth out any drops in dividends during retirement.

So I think some folk were quick to judge and wrote it off as irresponsible, without seeing the whole picture.  But it’s my error for not making my thinking clear enough!  Something I hope to remedy with this post.

Basically, I think due to the 4% rule studies which are mostly US based, some are convinced that living on returns higher than this, by definition, is unsustainable and a complete no-go.  I’m not saying those studies aren’t reliable.  They’re done by far smarter people than me!

But I am saying that there’s a few things that get overlooked and a blanket rule isn’t always fair (watch the pitchforks come out now!).

The US stockmarket and the Aussie stockmarket are different animals.  And dividend investing itself, is different too.  So let’s examine those differences, and see what we can learn.

 

US versus Australia

Firstly, I’m no market expert.  And I don’t have half the experience or knowledge that many people have.  But here’s what I see, when I look at the two markets.

The first thing to note, is the difference in dividend yields.  In recent times, the S&P 500 has traded on a dividend yield of around 2% (currently it’s 1.8%).  While the ASX 200 has traded on a dividend yield of around 4 – 4.5%, or 5 – 6% including franking.

In the US, the payout ratio is typically around 50% for the S&P 500.  But here in Australia, the payout ratio tends to be around 75% for the ASX 200.

Essentially, this means Aussie companies pay out more of their earnings as dividends to shareholders.  And therefore, US companies reinvest more earnings back into the business.

 

Why is this?

Well, it could be many reasons.  In the US, many companies are very innovative and growth focused.  Because of this, they retain as much cash as they can, to grow.

Also, they don’t have the franking credit system that we have, so paying dividends can more often lead to lower after-tax returns, once the shareholder has paid tax.

And in Australia, because of franking credits, companies are encouraged to pay out a higher level of dividends – since the franking credits are useless to the company, but very valuable to shareholders.

Here in Oz, we have a large amount of old, established and relatively slow growing businesses.  And quite often, these companies don’t have great growth prospects.  So they tend to pay out much of their earnings as dividends.

Sometimes they may see few growth opportunities, so they decide to do the smart thing and not burn cash chasing unlikely growth.  Instead, they sensibly pass most of the profits on to shareholders.

Other times, they may give in to dividend hungry shareholders, and end up paying out too much of their earnings.  This can eventually lead to a dividend cut.

 

It’s no surprise then…

Given the above points, it’s no shock that the US sharemarket trades on a higher Price/Earnings ratio (meaning it’s more expensive) than the ASX.  Because of lower payouts and higher growth expectations – people are willing to pay a higher price for a company/market that should grow earnings at a faster rate.

All else being equal, you would probably expect the companies with lower payouts to have better growth, and possibly better shareholder returns.  But, it’s not a given.

I’ve actually seen research showing that companies paying out higher levels of dividends, performed better.  This could be due to having an established and dominant market position, with less need for cash to grow.

Curiously, it could also be that the higher payouts force the company to be more disciplined with their capital, leading to better decisions and therefore higher returns.

Or, it could be that growth focused companies often spend without restraint because they’re chasing more growth and market-share in their industry (which may or may not pay off).

Either way, it doesn’t matter.  At the end of the day, it’s just not as simple as it seems.  High and low dividend payouts can be both good and bad.

 

Comparing Stockmarket Returns

Now, these returns are hypothetical.  Nobody really knows the future, let alone me!  But all we can do, is take the numbers we have today and make our own estimates for the future.  And for simplicity, we’ll just look at earnings and dividend growth.  We won’t consider share prices, for now.

Let’s take the US market first.  And we’ll assume that US companies can grow their earnings strongly into the future, due to the factors above.

So, a dividend yield for the S&P 500 of 2%.  Plus earnings growth of 6%.
Total return = 8%.  (Maybe a bit generous, but just go with it.)

And the ASX with a dividend yield of 4%.  Plus (slower) earnings growth of 3%.
Total return = 7%.

For some reason, let’s say we know the US market has a higher return for the foreseeable future.  Does that mean we should focus our investing there?  My answer is, not necessarily.

Dividend investors are looking to generate a strong, yet sustainable, growing income stream with their savings.  By investing in the ASX, which provides higher dividend income, we can create a larger level of income for our limited dollars.

Sure, if we each had $10 million to invest, different story.  Then, we’d have no trouble generating plenty of income from overseas shares.  But we’re not!  We’re working with much smaller sums than that!  And we’re trying to create a decent income with our savings.

In my opinion, the better choice for dividend investors wanting to retire early, is the Australian sharemarket.

So, in our example, we have a higher return from US stocks, because of the higher growth rate.  But we forgot something.  Franking credits!

Remember, when we’re investing in diversified LICs (like Argo, Milton, BKI or AFIC), our dividends come with the full benefit of franking credits.
Now our 4% dividend yield, becomes 5.7% grossed up.  Plus earnings growth of 3%.  Total return = 8.7%.

(To calculate a fully franked dividend, take the dividend and divide it by 0.7)

Honestly, we really do have a huge home-ground advantage by investing in our own backyard!

Overall, even if our market shows earnings growth of only 2% per year, versus 6% growth for the US – we end up with almost the same return (around 8%).

The difference is, our returns are mainly income focused, instead of growth focused.  There’s nothing wrong with that.  In fact, income-heavy returns are perfect for early retirees.

And we need not starve either!  This slow-growth scenario would likely still be enough for dividends to keep up with inflation.

(Side note – As a household, our spending is actually lower than it was 8 years ago when we joined forces.  And it seems to creep lower each year.  Maybe that won’t always be the case.  But it’s almost entirely within our control, which is important.)

So personally, we’re not worried about a super-slow-growth scenario.  It’s kind of a non-issue for us.  I would expect many frugal households experience this too.  With a little attention, it’s not hard to make sure your expenses grow slower than inflation.

Franking is mostly ignored in market and return comparisons.  And since it’s not a tax deduction, but a tax credit (real cash), this is plain nuts!  Sure, this brings it’s own risk that it could be taken away.

But I’m not sure it’s any more of a risk than anything else – personal/company tax rates, economic conditions, demographics etc.

And besides, even without it, we still have more attractive income returns and likely competitive total returns – as I outlined above.

As an aside, it would take roughly 20 years, for the low yielding US shares, to catch up with the income paid by Australian shares.

And that’s even assuming a much lower growth rate here and lower total returns.  See the example here in my other post on dividend investing.

 

Is Australia Boring?

So depending on how you look at it, Australia is perhaps a boring place for share investing.

Since the US market has been racing along for close to 10 years now, many Aussies are looking abroad to invest.  And it’s not hard to see why.

In the US, there are some of the most exciting and innovative companies in the world.  But because of this, their share prices are flying high and many are double or triple what they were just a few years ago.

In comparison, Australia has been slowly and steadily inching back towards it’s pre-GFC high.  Our market has certainly been boring in comparison to the US, no doubt.  But it should be noted, dividend investors have still been receiving a strong level of income, which has been rising since the GFC low.

My thoughts on this are split.  If you’re focused on getting the highest total return, then you will have been much better served investing in the S&P 500 (for the last 10 years at least).  But if you’re following a dividend investing approach for solid income, you’re probably still better off investing in the Aussie market.

The dividend yield is double, plus we get franking credits, which makes the gross yield currently about triple the US!

To be honest, which market outperforms in the next 10 years is anyone’s guess.

Quite often, one market will perform better for a decade or so.  Then, in the next decade, the other country’s market will do better.

At the end of the day, it’s not even about which market outperforms.  What it’s really about, is which type of investment is going to meet your personal needs/goals.

For those of us passionate about early retirement, we need a strong and steadily growing income stream.  So our dividend investing is better focused on the market best suited to provide that – the ASX.

 

Australia’s Outlook?

Here’s my simpleton take on things – Australia appears set to be one of the higher-growth developed countries.  We have high population growth, relative to many other nations.  And this bodes well for company earnings (more customers) and therefore dividends into the future.

Now it’s true, the ASX is a concentrated market with over 35% financials and the top 10 companies making up around 50% of the entire market’s value.  But we can reduce this risk by also investing in LICs that focus on small/mid sized companies.  I spoke about this here (I’ll review some of these LICs in the future).

This way, we get a much more diverse spread of companies, which operate in different sectors, while still generating strong dividend income.  And by increasing our diversification this way, we benefit from the broad growth in the Australian economy.

But obviously, if you feel Australia is going down the crapper, this won’t matter.  And investing overseas makes a lot more sense!

 

Cautious Optimism

I’m optimistic about the future.  But I also don’t want to get carried away and expect too much from my investments.  While my figures seem too generous to some, we have personally built in some safety margins.

Firstly, we have more savings (equity) than required to meet our income needs.  Next, we also keep a decent amount in cash (around 1-2 years living expenses) to smooth any times dividends are reduced.

We’d also look to spend less in that situation, or create some part-time income to make up the difference.  And our expenses are likely to grow slower than inflation, giving a further safety margin if dividends grow very slowly for a long time.

There are many types of backup plans you can put in place (future article planned).

 

Bogle’s Calculator

It’s worth noting, estimating future investment returns need not be complicated.

Even John Bogle himself (founder of Vanguard) uses a very simple equation when he looks at the markets.

He says in this interview, that a reasonable expectation of future returns is…

Today’s dividend yield, plus earnings growth – what he calls ‘fundamental return’.
And then the change in valuations (Price/Earnings ratio) higher or lower – which Bogle calls ‘speculative return’.

It’s important to realise that this change in valuations, is nothing to do with the earnings of the companies.  Therefore, also has nothing to do with the dividends paid out by those companies.

It’s merely the share prices people are willing to pay.  That’s why Bogle calls this part of the equation ‘speculative return’.

Dividend investing for early retirement is far more reliable, because it’s based on fundamentals (dividends plus earnings growth), and not reliant on the speculative side of things (fluctuating prices).

Who cares what people are willing to pay for shares tomorrow or next year?  What we care about is the economy and company earnings, which is where our dividends come from.

Funnily enough, he’s also said – we should be investing for income, focusing on the dividends in retirement and not stock prices!  It’s refreshing to see such a simple thought process, for such a titan of the investment industry.

 

Keep It Simple

So it seems to me, dividend investing is a fairly sensible way to go about retiring on shares.  And the figures we’ve used above, also seems to be fairly realistic.

I’ve noticed some people get stuck in the weeds trying to calculate future returns.  And agonising over formulas and charts to see how much of their portfolio they can live off.

To me, it’s simple.  Provided we’re invested in quality LICs or Index Funds, where the dividend income can reasonably be expected to rise (at least) with inflation over time – we can simply use the dividends to live on.  And also keep some cash to cover any bumps in the road.

The less flexible you are with your lifestyle, spending, ability to work – the more extra cash you’ll likely need.

Related Post:  Long Term Investing & Shrugging Off Sharemarket Falls.

 

Dividend Investing meets Early Retirement

There’s another way that dividend investing fits snugly into our financial independence plan.  And it’s another perk of the tax system.

Currently in Australia, we have a tax-free threshold for individuals of $18,200, plus a ‘Low Income Tax Offset’.  So it works out, we can actually earn $20,500 of income per year, and not be up for a single dollar of tax!  (Check this calculator to see for yourself)

What this means is, a couple can earn $41,000 per year tax-free.  Effectively, our own retirement spending can be funded from $700k of Aussie LICs that are yielding 4% fully franked (5.7% gross).  And we’ll pay absolutely no tax on this income.

Above this level of income, regular tax rates start to apply.  But still, it’s a pretty generous system.  Maybe the government feels sorry for us living on a low income 😉

Dividend investing in Australia, can potentially allow you to retire on a juicy income stream which is very low tax, or even tax-free!

I’m not saying it’s a perfect strategy.  But I am saying, it makes a lot of sense for our situation (and likely many others too).  Most importantly, there’s no need to sell-off shares for income during retirement – something I’m not a fan of, as I outlined in this article.

 

Final Thoughts

Dividend investing may not be for you.  And that’s OK.  We all need to choose an approach we’re comfortable with.

But I hope this makes my thinking more clear.  And why I favour dividend investing – which is really just investing, but with a dividend focus.  I don’t see much of this discussion by other bloggers, so I wanted to share my thoughts.

Maybe it’s just me, but I feel as though owning 100-200+ different businesses in Australia – through LICs or an Index Fund is reasonably diversified.  And with much higher dividend yields here, plus the benefit of franking credits, the income is just too good to pass up.

Then, we can also add international shares if we want to reduce our risk and diversify our funds further.  Personally, we’ll be doing this later, once our Aussie portfolio is fully established and covering all our bills.  I see international shares as a ‘nice to have’, not a ‘must have’.

Here’s one way to think about it:

Focus on building the required dividend income for financial independence first, through Aussie shares.  Then with any additional funds, look to add international shares for dividend growth, and to further diversify.  I looked at different allocations to each in this post.

It may seem flawed or biased to some, that’s fair enough.  But putting this all together, I think dividend investing is perfect for Aussies shooting for financial independence!

If you want to see exactly how to implement this Aussie Dividend Strategy, download my free PDF guide: “Your Simple Step-by-Step Guide for Passive Income” – Get your copy here to read at your leisure.

91 comments

  1. What a cracker of an article – thank you. I get so sick and tired of folks chewing my ear off about my love of dividend investing (even though dividend investing is only 50% of my portfolio, the other half being VGS and VGAD).

    VHY announced its quarterly dividends the other day – you simply can’t beat the feeling of dividends being announced then paid. Argo, AFIC and Milton will not be too far away either ….can’t wait.

    I treat Ozzie dividend investing the same way US treats bonds. LIC’s 100% franked are my ‘bonds’.

    Phil

    1. Thanks Phil!

      Nice – you have a much more well rounded portfolio than me at the moment. But we’re quite income hungry at this stage.
      VGS will be our index of choice too, when the time comes. I just see dividend investing as a different approach to the sell-down method. It’s like some folks buy property for growth, others for cashflow. It’s a different focus.

      Haha I share your excitement! Looking forward to the reports and not long after, the dividends 🙂

        1. I actually used to hold it, but don’t anymore. In theory, it sounded really attractive. But when I was holding it, it ended up having large positions in stocks like BHP and RIO because of their huge ‘forecast’ yields at the time but were becoming obviously unsustainable (BHP’s payout ratio was forecast to be something like 250%). The index didn’t kick those two stocks out until their dividend cut, which sucked. Also, I remember receiving really lumpy distributions – a bunch of capital gains, due to them changing holdings to the new ‘forecast high yield’ stocks, which wasn’t ideal.

          The performance seems to have been pretty decent, but I ended up deciding I just don’t like how the product works in practice. Have looked at it since a few times, and the top 10 holdings tends to change a fair bit, implying turnover and capital gains paid out. I’ve decided I prefer the predictable nature of the older LICs with dividend smoothing. Also if there’s capital gains from sales they can retain it due to the ‘company’ structure, or pay it out as a special dividend where we get the CGT deduction as if we owned it ourselves.

          Overall, I like the company structure better and the predictable dividends. I’d be happy to hold the plain vanilla index funds though like VAS or VGS, despite lumpy distributions and some cap gains paid out.

  2. Great article – very detailed. I love dividends and the franking system. If you are looking at achieving FIRE, this can be combined with super contributions to reduce tax prior to age 60 and then drawing down tax free after 60 from super or your own SMSF.

    1. Cheers, and appreciate the tip.
      We’ll look at strategies like that a bit later. Given I’ve just retired, yet still have roughly 31 years until super access, I’m not looking at throwing extra cash into super just yet! But later, we will definitely look to use it to full effect.

  3. Question: I don’t fully understand how franking credits work, so I would like to write a scenario and I hope you can help.

    I earn $150,000 a year as normal income (not retired yet)

    I buy a share worth $X which pays me a dividend of $10 per a given tax year fully franked.

    How much tax do I pay on the dividend?

    My top tax rate is 37%, that means that the $10 that I got, i’ll have to pay taxes of 37% on it meaning $3.7. Since, its fully franked meaning that the company already paid $3 tax on this, so I guess my tax will be reduced by this to $.7.

    So, I have to pay a tax of 7% on my dividends? Is that correct.

    Now if I own US shares worth $1000,000 which has a dividend yield of 2% (20k), I pay a tax of $7400.
    Same with Aussie shares, if it has dividends of 4% (40k), I pay taxes of ($2800) if its fully franked. If its 50% franked, then i’ll pay 22% tax (15% which company didn’t pay and 7% extra from myself) i.e. $8800.

    Is this line of thinking factually correct or am I missing something? It seems like it depends heavily on your income if more dividend including franking credits is good for you. Also, it depends on how much franking credit is provided by the stocks you own. Do you know some place where we can find stocks (or their packages, such as index funds or LICs) with high dividend and good franking credits?

    1. I’m not sure about the franking, but as for finding index funds and LICs I’ve found etfwatch.com.au fairly helpful.

    2. Yep, sounds like you’re on the right track.
      If 30% tax has been paid – you pay the difference. Or, you’re refunded the difference if you’re tax rate is less than 30%.

      You’re right about thinking about it all in percentage terms, that’s what I do. And when it’s all in the same tax bracket, that’s correct.

      But in that scenario, you creep into the higher bracket (income goes over 180k), so there’s likely a little extra tax to pay.

      Investing for income is more effective with a lower tax rate of course. But eventually we want to live on the investments in retirement (usually much lower tax brackets) so we want that same good income to be there. We don’t want to be switching investments, say from growth first to income later.

      There are other options available to high income earners such as Bonus Share Plans, which I spoke about in this post. Essentially, you can receive extra shares instead of dividends, meaning no income needs to be declares. You also don’t get franking credits thought – so effectively anyone on a higher tax rate than 30% would benefit from that. So if the dividend is 4%, you receive that in shares instead of cash. The catch is if you sell, your cost base is basically reduced because you have shares which didn’t cost anything and it lowers your average price – therefore you’d pay a bit extra capital gains tax. These Bonus Share Plans are only offered by AFIC and Whitefield (both good quality, long term focused LICS). It’s a good option as it can mean higher after-tax returns for high income earners wanting to accumulate shares over a long period – better suited to those with no intention of selling! Worth taking a look at though.

      Other than that, there’s plenty of good LICs which offer yields around 5.5-6% gross – many I spoke of in this article. There’s also others such as Platinum Capital (PMC) and WAM Research (WAX) which are a bit different but offer higher yields. Vanguard has a high yield dividend fund (VHY) also. Do your own research here as I’m not an expert or advisor. And it’s important to note that yield isn’t everything. We need our income to grow over time also. Very high yields often come with high risk or little to no growth

  4. Phew that was a long post. Great effort young fella.

    Terrible things those dividends. I have to keep finding things to spend them on. Fortunately my favourite thing which brings out the shopaholic in me is buying more dividend paying LICs:-). But then I have even more dividends to spend. So round and round we go. All very stressful.

    Must admit we mostly secured our income with Aussie dividend payers first before really doing anything much about International exposure. The only LIC that we’ve held since early on with an International focus is PMC. And that was because it’s unusual in paying quite a decent fully franked dividend. Then again there wasn’t much choice either back then. However PMC’s still not as a reliable dividend payer as the ASX focused older style LICs.

    The total return index types tend to be critical of dividends. But I just ignore them. I really enjoy the dividends consistently rolling into our accounts with no effort on our part. No having to decide what to sell or sleepless nights as a result of capital volatility when needing to convert capital to income for living expenses.. Dividends, pure bliss.

    Cheers

    1. Thanks Austing.

      That does sound stressful! If you’re having trouble with those dividends, pass them on, I’ll unburden you 😉

      Appreciate you sharing your story. That approach makes sense to me. I do like PMC but the reliability of it’s dividend is a bit of a concern (not a great history). I’d prefer a lower, but more stable, steadily increasing dividend. Do you know what happened historically and if it’s more reliable now?

      I’ve just a different approach I guess, no right or wrong – but yes they can be pretty dismissive of dividends. Personally, I think it makes way more sense, no matter what country you’re investing in. The income approach is just much simpler, less decisions to be made and less to think about. Maybe we’re just lazy!

      1. Re PMC the dividend was less reliable prior to 2010. Since then changes to company accounting rules relating to the solvency test make it much easier for the “trading” LICs to pay dividends especially during difficult market times.

        PMC was a compromise to us earlier on in that it at least paid a decent dividend compared to other International focused LICs. Probably in your case continuing to focus on Aussie LICs gives you the reliable income you need now. I mostly bought into PMC and the like when they are great value unlike the older style LICs which involved more steady Accumulation.

        Hope that helps.

        1. Thanks mate, it does help.

          Their outperformance of the International index after fees is very impressive over the 20+ years they’ve been running. I like that they have an all-world exposure including Asia. It’s on the watchlist for now.

          1. Yeah I Iike PMC for the strong Asian tilt (but not restricted to Asia only) where I think an active Mgr can add value. It’s a good compliment to VGS large / mid cap developed International where active Mgrs struggle badly to add value.

          2. That’s a good point. They’ve definitely done that. And it does seem like a nice add-on to VGS. VGE also looks quite suitable, albeit with lower income than PMC.

          3. Hi SMA & Austing,

            Is there a set percentage of your dividend income that you reinvest back into LICs for long term growth? Currently I’m managing investments in AFI, AMH, BKI, FGX, MIR, MLT, PIA, SOL, URB and WHF that will transition to me as part of a future estate. I’m currently trying to reinvest 100% through DRP where offered, but that will change when I fully retire – I’m 65 and working part time.
            Regards
            Ynot

          4. Thanks for the question Ynot.

            There’s no set percentage as such. It depends on your personal cashflow needs. I receive dividends in cash and reinvest in what I want to buy at the time. So if one is still accumulating then I’d be making sure 100% is being used to buy more shares.

            The LICs you hold will be able to grow their dividends over time, which means the value of your holding will increase too. Meaning growth in income and capital growth. Even if you don’t reinvest any dividends in retirement. Reinvesting some will give an even better outcome. When you retire, if you live on the dividends and have more income than you need, then definitely, if you can manage to keep buying a few shares that would be excellent.

            So I don’t think it’s entirely necessary, but it’s good if you can manage it. Hope that helps 🙂

    2. Austing

      Sounds like a vicious cycle you got yourself into.

      You can always share the dividends with me if you want… I give PM you my bank details

  5. i will take a proper time to diggest the whole info but i really like the approach. in the end doesn t matter which path you choose as long as it suits your needs and investment philosophy.

    one thing that has left me out of LICs and its dividend (i do have some in my portfolio) is the lack of diversity. at present australia has got the highest debt pp in the world.

    as long as the strategy takes into account exit points just in case you ll be safe. so someone who has a 30 year plan it is ok, but for us who want to RE its good to have a back up plan or be ready to work more years to sustain a crash. inevitable in my opinion.

    1. Exactly. Everyone needs to find something they feel comfortable with.

      Australia’s debt is a concern to many. It’s not a great thing I guess, but the numbers I’ve seen show that the amount of interest we’re currently paying as a portion of our incomes is very low – although it’s increasing.

      This is where international shares come in. For many people, they don’t want to take the extra risk having all their investments in one country. It’s a good idea, and part of our long term plans.

      I don’t agree with creating exit points, if you mean selling? The whole point of long term income focused investing is for us to accumulate over our lifetimes. Whether it’s index funds or LICs, the goal is to hold for the foreseeable future. Exiting the markets is almost always a horrible idea for anyone’s long term wealth, and I don’t expect that to change.

      You’re right though, backup plans are a must! No plan is bulletproof!

      1. Yup. the high debt level in this country concerns me and hence the major concern when investing in Lics…given most Lics have banks making up >30% of their portfolio.

        But it seems most Lic Managers are aware of this, I mean they seemed rational and should be aware of this…so why do they still keep banks if its a major risk ?

        In terms of investing oversea, we shouldn’t invest oversea for the sack of diversification alone, if US shares are overpriced, diversification for the sack of diversification doesn’t make too much sense…especially given the low AUD

        1. Yeah they seem to think the risk of catastrophe is low. And we should remember they’re much smarter than us, but doesn’t mean it can’t happen.

          The best way to dilute banks is to buy small/mid cap LICs to give a better spread of companies and sectors (perhaps like QVE, MIR, WAX). I’ll write about these in the future.

          I see what you’re saying about overseas shares and valuations – but we will only really know if they’re overvalued in hindsight. Earnings could keep growing strongly and then the price is justified – who knows. When we focus on prices and wait, we’re effectively market timing which mostly works out poorly. It’s hard though, I hear you – but less over-thinking is probably better.

          One approach is to find a portfolio and weightings that you’re comfortable with, then just keep accumulating whichever needs to be topped up to keep to your target portfolio allocation, regardless of valuations. That way, we’ll be averaging in and adding to the index funds/LICs that are cheaper at the time. It’s really the Bogleheads index fund approach, but it can be used for LICs also. Maybe I should write (a beginners take) on portfolio allocation at some point…

          1. I don’t really have a magic formula, some thoughts here if you’re interested in adding international shares too. If not, just a couple of old-fashioned LICs or the index is fine for me. And maybe an LIC which focuses on small/mid sized companies for some extra diversification if not adding international shares.

          2. Hi Dave and fellow travelers .
            Currently l am struggling with the topic of allocation for a new phase of my portfolio construction , which is to say optimal allocation , if such a thing exists of course .
            Best wishes , Ramon .
            P.S . l am retired and need to make my portfolio much less volatile , especially since l would like to leave a balanced income-earning portfolio to my family .
            Thanks for the opportunity to comment .

          3. Thanks for the comment Ramon.

            There is no ‘right’ portfolio in my mind, just whatever suits the individual. If you’d like less volatility, the easiest way to do that is to invest less into the market, so keep quite a bit of cash or bonds, and with the rest you can invest in income-producing assets like shares. You can then decide how much you’d like invested in Australia vs international and go from there. If you would like higher dividends, you may wish to have more of your money in Aussie shares, but if you aren’t fussed with that then you may wish to split your money equally between Aussie and international shares. Hope that helps a bit.

  6. Hey SMA,

    Excellent article and thanks for detailing your thoughts and your process in how you did it. I’d like to think we are following in your footsteps, except we’re 10 years behind 🙂

    As you have excellently outlined, the Australian LICs can perfectly set up a retiree with the higher yields and as long as the income slowly grows faster than inflation then everything works out. Just hold and let the dividends roll in.

    Australian LICs are wonderful setups, but my only ‘concern’ would be that the index-similar LICs rely on the big stocks and the Australian economy in general to do well. It’s been 25 years since Australia’s last technical recession, so it will be telling what happens what happens to those LICs (and their portfolios) when a recession next hits. We are shareholders in several LICs, but only ones that have shown they can beat the market (after fees) plus pay out a growing dividend, I’m sure you own a lot of those as well. So far, we have avoided the big LICs. Just my own thoughts on why we have a very similar end-goal but our share holdings are perhaps a bit different 🙂

    Mr DDU

    1. Thanks Mr DDU!

      I’m sure you guys will do just fine – it’s good to see your portfolio steadily growing 🙂

      You raise a good point, the old-school LICs are reliant on the largest companies. There will be surely be drops in dividends in a downturn, so we need to plan for that. I wouldn’t feel entirely comfortable relying on just those as a portfolio, which is why I think it’s good to hold some other LICs which focus on mid/small size companies too. That way our income stream is coming from a wider blend of companies.

      I plan to share a hypothetical portfolio at some stage, to give an example of improving diversification while still being Oz only. If anyone wants to go one step further and add International as well, that’s likely a good move, although will dilute their income.

      Appreciate you sharing your thoughts here!

  7. Great write up, quality stuff. I have yet or understand clearly myself, a comparison of tax effectiveness, i.e. your chosen strategy vs a total return one , in the Australian landscape, at lowest tax rate for someone RE, pre-super.

    For example you can withdraw $41,000 tax free via income splitting over 2 people, with $700,000 worth of AFIC. Nice, simple, solid, clear.

    If you then want to withdraw the $41,000 – What would $700,000 of VDHG returning 10% for example get you. Mix of spending the dividends and selling portions to reach $41k, what would the cap gains tax be? Assumed say the portion you had to sell had grown 10% , for example.

    Or, what would $700,000 of VGS last year returning say 13%, that you then again assumed say the portion you had to sell had grown 10% , for example. You then pay cap gains tax at 50% on the portion you sold to make up the dividend balance…..

    Then what would be the balances of the three funds end of year after income paid out, tax paid ( none in the case of your LIC strategy) , and any sales of stocks, plus growth of all three. Interested in any thoughts on the net result. I know the assumptions have variables but I assume you have done the numbers on these before going down the LIC path?

    It hurts my head trying to figure this out.

    Any takers? Thanks!

    1. Thanks, glad you enjoyed it.

      Wow, that’s a tough one!

      So this is where the two strategies kind of part ways (the indexing withdrawal vs living on income). With the dividend approach, there is literally nothing to be done. The cash just comes in, no withdrawals, no selling, no cap gains.

      I’m not sure there’s an easy way to calculate that scenario, because it would depend how long the funds held on to the underlying stocks and how much cap gain was associated with each holding. Also there’s rebalancing that occurs which adds another layer of complexity in trying to figure this out. I’m just not sure I can answer it and I don’t think it’s that simple.

      This is part of the reason I prefer the dividend income approach. There’s no rebalancing, no selling, no cap gains taxes. Nothing to do and no decisions to make. Just income coming in. The behavioural thing was another reason for my choosing dividends to live on. I don’t have to look at the market, if stocks go down it doesn’t matter.

      So even if the net after tax result is better for the total return approach, I prefer the pure simplicity of dividends.
      Sorry, I know this wasn’t the answer you wanted! But it hurts my head too, and I put it safely in the too-hard basket 🙂

  8. Reading mostly American sites, I’ve never thought positively of income generating companies over growth-centred companies. This really helped understand the other side of the story, so cheers for that.

    Do you know if the Aussie market has an Aristocrat dividend fund at all? I can’t seem to find one, and I thought it could be because we simply don’t have enough companies to make such a list.

    1. Thanks for the comment Luke!

      I don’t think we have such a list – not that I’ve seen anyway. The best we could do if picking individual stocks is just to look at stocks one by one, for their dividend history.

      Or, what we do personally, is leave it to the low-cost LICs to pick big basket of dividend stocks, and pass the dividends on to us 🙂

      In effect, you receive a steadily increasing income over the years/decades, despite the variation in performance of the stocks in the portfolio. Similar result, for less effort!

  9. Great article, thats me you are talking about , just retired under 60 years of age and doing it via dividends.
    I also have term deposits because I like to sleep at night and having all your money in the ASX is still a tad risky even with Blue Chippers, your Rolls Royce LIC’s and ETF’s. Nothing wrong with your mathematics either, being married like me gives you big tax advantages and if it doesnt come with Franking credits then I wont buy in
    Saying that your income stream needs to be fairly regular ie you need to be receiving Dividends every month to be able to live so the way around that is
    working out what stocks pay dividends in which months and you need a couple of the good REIT’s to make that happen in the months where your big Blue Chippers, LIC’s and ETF’s dont give you a divvy. REITS pay quarterly but the downside is no franking credits but most are paying 5% plus so its ok.
    I also Dividend strip/hop with some success and make some extra money, you have to add up the total franking credits and watch the 45 day rule for tax purposes but generally I make it work and get some extra pocket money .

    1. Thanks for sharing Mark!

      I really think the approach meshes in nicely with early retirement.

      I’m not too fussed about when dividends are received. I’m happy with just twice a year, and have a bunch of cash in the bank that can be replenished as the dividends roll in. I own a couple of REITs too, though not much. Prefer the Rolls Royce LICs as you say 😉

      That’s interesting with the dividend stripping. I believe that’s what the new LIC Plato do (PL8). Good to see it works for you. Probably not something I’d do. I’m far too lazy for that, prefer the set and forget stuff.

  10. Dividend stripping isnt for everyone and most make the mistake of looking at individual company’s. I prefer ETF’s using the Daryl Guppy techniques…Guppy writes share trading/investing books and is one of the more practical trading authors.
    ETF’s are not as volatile and the price often doesnt drop by the dividend amount if ay all after the ex date. You never pick something you wouldnt own long term and it can be very satisfying getting a win, but I take your point about the work required.
    Bit of a random question….HBRD from Betashares…any thoughts?….

    1. I would have thought ETFs were priced to perfection since their asset value and price aren’t seperate like an LIC. I know very little in this area, but how can that be?

      I’m not really up to speed on Hybrids either. See a pattern? I’m no expert 😉 At first glance, HBRD doesn’t look great to me. Almost entirely bank exposed. Fee is 0.55%. There’s a performance fee also. Gross yield is 4.8%. Unsure of growth prospects, do hybrids grow in value? Not something I’d buy – don’t understand it well enough. Seems more attractive to own the bank itself, which we do via LICs. Just stick to dividend shares and cash for us – nothing fancy 🙂

  11. HBRD was recommended to me as a monthly income payer and having low risk due its liquid nature of being able to switch to a bonds/cash bias when the market got tough but I didnt/dont know a lot about it either. The 90 % banking exposure put me off too given I own some of the banks outright and we all have them a couple of times over in our LIC’s but I’m not negative on Banks like a lot of other investors who read the daily guff from Motley Fool etc who push the anti bank line…..
    Think I will watch from a distance, thanks for the reply and opinion…

    1. To be fair, any investment with active management can usually switch to higher cash levels if they deem it prudent.

      Completely agree there mate. Many people like to bash the banks and I think it’s because nowadays they’re pretty boring. They’ve turned into slow moving dividend stocks. But the banks probably do fine over the next few decades purely from population growth (much more loans written) despite their other risks. They probably won’t outperform the market, because…they are the market. They probably stay as strong dividend payers though, with some growth over time too.

      That said, you don’t want too much exposure to them (via old LICs) so I think it makes sense to add small/mid caps or international or both to a portfolio.

  12. Agree on the Micro, small/midcaps, I like my Wilson LIC’s, WAM,WAX, WMI, WLE etc, anything Geoff Wilson is involved in usually gets it done for the Investing Punters.
    You get some good Divvies, growth and he and his crew usually have their own money in them but he doesnt get carried away and is prepared to stay in cash when there is nothing to buy unlike some of the other fund managers who want to stay fully invested and buy high risk stocks….

    1. Yes we hold a couple of Wilson LICs ourselves (WAM & WAX, prefer WAX). They certainly have a good track record and and paying large dividends is a focus for them it seems. Dislike the fees though, they’re pretty excessive. Also they have a bad habit of only showing ‘portfolio performance’, which is misleading for the end investor – we don’t see that return at all. Still had good performance net of fees, but it just makes it harder to keep up that out-performance and deliver a good net return to the shareholder.

  13. Hi SMA,
    I am very excited for your hypothetical portfolio to come out. This will give me a very good idea as what is required. What I think would be good is when you do this portfolio we could track it and see what dividends are paid. I think the mixture of large, mid and small cap LICs is a great idea. I will be interested to see how many LICs you will have in each sector.

    1. Thanks Jason 🙂

      It’s quite a hard thing to do – it’ll just be a bunch of random ideas really, nothing scientific about it at all. Because we’ll all be comfortable with different portfolios and different levels of diversification. Some will want heavy overseas shares, some none.

      There’s definitely no portfolio that’s right for everyone, but I hope to share some thoughts on what a portfolio might look like, depending on ones own goals, level of interest and comfort levels.

  14. Great post SMA. Love your work.

    Couple of questions. Are there any links where someone could work out how much an invested amount would have grown to if invested 10 years ago etc or longer, for investing in LIC’S. For example how much would $10k be worth today if invested 15 years ago.

    And are there any links to see the historical performances of the LIC’S as I can only find 10 year returns for the LIC’S suggested.

    And in terms of preserving the capital indefinitely (as per 4% SWR rule), how exactly does this work with living of dividends income. For example if one owned an investment portfolio of $500k in three LIC’S and the average div payout was 4% and then grossed up to 6% etc. that would be an income of $30k for living expenses. Say you are aged 35 and if inflation tracked at 3% for the next 50 years and you needed it until death, say 85yrs but the capital growth for the initial $500k in holdings of LIC’S averaged 2.5%, this would mean you would run out of capital, well before death, if you lived of dividends. This example is the same for $400k or $2million, as it’s all relevant to your expenses, and if you are relying on the dividends to cover expenses. Either way you will run out of capital at some stage.

    Obviously to combat this you could work part-time and earn $10k per year and then only use $20k of the dividends and reinvest $10k. But if you didn’t want to earn any income through working and just live off dividends, then it will always run out to early.

    I am not sure what the historical performance of the LIC’S are in terms of growth and growth outperforming inflation? If the growth long-term growth is 3% and inflation is 3%, then the $500k invested will keep pace with inflation and last indefinitely, if it’s 3.5% then it will grow and there will be some left over to pass on to children.

    I might be getting it wrong here? Please correct me if so.

    1. Thanks Fergy.

      Well, you can simply look at the 15 year returns for Argo which is on their website somewhere, and for Milton which is on their monthly portfolio statement. Otherwise, there’s a 20 year chart here which includes dividends reinvested – https://cuffelinks.com.au/lics-vs-berkshire-imputation/ – so it looks like about 6 or 7 times your money. Returns were around 8-10% per annum I believe. The long term is similar or higher, but the future is unknown of course.

      I’ve also mentioned longer returns in a few of the LIC reviews here on the blog. Especially relating to dividend growth versus inflation and how these LICs have been able to grow dividends faster than inflation for as long as I can find record for. This tends to be the way for equities broadly, the US market is the same….

      Businesses generally manage to increase their earnings faster than inflation due to new products and technologies, innovation and becoming more efficient, this also allows them to pay us wages that grow slightly faster than inflation due to us being more productive too, meaning we all become wealthier and our living standard increases over time.

      It’s grossly oversimplified, but this has roughly occurred, on average and over time for as long as we know, I personally don’t think it’s about to stop anytime soon.

      1. Thanks for the reply SMA.

        So say for example my expenses are $40k per annum. If I have a portfolio of around $700k then this will generate around $40k fully franked dividends per annum. So therefore I could live of these dividends indefinitely, and if I had a cash reserve of $80k to tap into In the event of a market crash, this will preserve the capital and allow me to live off the dividends indefinitely. Is this the strategy you adopt?

        Of the overall performance of the asset is 8% compounded this would mean we are using 6% of the return to fund our lifestyle indefinitely.

        Just want to make sure I am getting this.

        1. Yeah that’s pretty much it.

          To be more conservative you can treat franking credits as a bonus, since there’s a chance they may be tampered with. So you’d then look to have around $1m of shares to spit out $40k of dividends.

          If franking credits stay the same then of course we get more income than that. We’re really only spending 4% of the actual ‘return’ because all the studies and market return forecasts etc. completely ignore franking credits. They’re really just the cream on top but currently make a huge difference to income 🙂

          1. Thanks for the reply.

            Yes I think a conservative approach as you suggest could be a suitable option and treating the franking credits as an annual bonus, that can be reinvested capital preservation.

            Thanks for the clarity.

            Fergy

  15. Now it’s just a matter of determining how to spread he risk. I was thinking either four LICs at 25% tilt each or three at 30% each and then 10% tilted towards low cap stocks etf or VGAD for another growth element.

    1. Up to you of course, but I would go for higher than 10% if you wanted to add international shares. At 10% there’s maybe not much point. You could go for 20-25% and still have a decent yield overall. I shared some different allocations and the income/growth profile of what that might look like here – International Shares for Aussie Dividend Investors

      I’d personally choose VGS – using the hedged version adds slightly more costs and the currency movements would probably even out over time. The distributions from the hedged version are often more lumpy and could result in extra tax payable.

  16. Cheers SMA. That makes sense. I enjoyed the link to the above article. Well written.

    If you are invested in a few different LIC’S, do you re-balance every year? Is the re-balancing principles with ETF portfolio’s the same as with LIC’S?

    For example if you wanted 25% allocated to each LIC, would you be re-balancing at the end of each year. I assume this would trigger CGT.

    Regards

    John

    1. Thanks John 🙂

      Well you could re-balance between them, but I probably wouldn’t. Because the old LICs will likely all perform similar to one another it will probably even out over time.

      The only re-balancing to look at may be the international allocation. When you’re accumulating this is best done by directing new money to the investments you need to top-up. When spending the income from the portfolio later, you could re-balance a little but I probably still wouldn’t bother.

      The overall income from the portfolio should grow with, or faster than inflation so there’s really nothing to do. The international component may (very slowly) increase as a percentage of your portfolio due to higher capital growth but that’s no issue really – what matters is the growing income. If that bothered you, you could re-balance a little every few years or so. As you said there’s CGT to consider so best done minimally, if at all.

      When in doubt I think simplicity should win out.

  17. How often do you think one should buy stocks in each LIC? For example if I am saving $4 per month is it best to purchase $4k worth of shares each month or less frequently. Would it be best to buy equal holding of each LIC or buy the LIC that is best value at the time. Once I gain a better understanding of NTA etc.

    1. I think $4k is fine, I mean if your brokerage is only $10 or $20 it works out to be only 0.5% or less.

      Probably doesn’t matter too much John. The prices will likely even out over time so you could simply go even amounts. But if you can be bothered looking at NTA each time, you could do it that way to try and buy the ‘cheapest’ one at the time. It’s often debated, I don’t think there’s a perfect way to do it 🙂

  18. I was thinking another strategy would be to invest after tax dollars into LIC’S and this could be the Australian exposure component of the portfolio and then invest pre-tax dollars and SG into International stocks, if your super fund allows so.

    That way any capital growth in the Super Fund is taxed at 15%, contributions are pre-tax and you have exposure to International Stocks.

    My Super Fund allows me to choose my investment within their investment products. So I currently have 50% Australian Shares, 25% Int Hedged and 25% Int Unhedged. Closer to retirement age I may rebalance to a more defensive allocation.

    This way my super is more geared towards Growth up until I can access it and need it, and then my pre-retirement income will be from Divs and CG tax will be lower through the accumulation stage.

    I’m not a financial planner, so I could have this wrong, but from research it seems like a sound plan.

    1. Yep that’s a good idea which I mention in my post on having international shares.

      To keep it simple, starting today I’d probably set it up as 100% oz outside super and 100% international inside super. Oz shares for early retirement income and international shares for long-term growth and somewhat of a backup plan later on. There’s no such thing as a perfect portfolio, only one that meets our personal needs/goals combined with realistic expectations.

  19. Cheers Dave,

    Yes I wasn’t sure whether to go 100% Int in super or not. Do you know if I change my allocation in my super in say 20 years time from 100% int to a more diversified defensive portfolio, does this trigger CGT within super?

    Also do you currently contribute to your super via your current passive income? If so what percentage? And would this reduce your taxable income if you did?

    1. I can’t say for sure, but I would guess that it would trigger CGT. It’s still assets held for you that’s being sold. The difference would be if you had entered pension phase or transition to retirement phase I believe.

      No we don’t contribute anything currently apart from the small amount going in from my partners part-time work. We’re still building the income stream as we convert our property equity into shares so we’re focusing on that. Yes this would reduce taxable income if we did, but that’s of no concern as we still have negative cashflow properties so our taxable income is very low anyway.

  20. Cheers Dave,

    Yep makes sense. Just checked on Money Gov site and yes re-balancing of any sought triggers a CGT event at 15%. But if in pension phase there is no CGT AS YOU STATED, AS LONG AS SUPER IS BELOW $1.5MILLION.

  21. Hi Dave,
    In regards to Property vs Shares: aren’t tenants paying for one investment and you’re self funding the other? Ignoring returns for a moment, wouldn’t property be more cost effective by having someone else pay the bulk of the investment costs (via rent)?

    1. It sounds like it yes, but most capital city investment properties are negative cashflow unless you put in a substantial deposit. You can see my thoughts and experience with property investing here .

      I know an investment property sounds like a free investment, but it’s far from it. There is the very substantial purchase costs involved via deposit and stamp duty etc. If the income does equal the bills, you can see it in the sense that at least it may be paying for itself, even though there’s no leftover. Or, you could see it in the sense that it’s not profitable and you’re simply banking on future capital growth, which is how most investors approach it.

      1. and also most property investors take into account returns based on interest only loans. and we know we then might have a shocker when it reverts to P&I

        1. That’s true. Most investors (myself included) have never experienced a time of essentially mandatory P+I loans – except for those who can prove strong serviceability and possibly get around it. It changes the cashflow position dramatically.

      2. Thanks for the reply Dave. I can see what you’re saying. As a first time investor, I like the thought of having someone else chip in with the payments. Obviously there’s no cashflow during the years the renter is paying off the mortgage, but it would be similar with reinvesting dividends, no cashflow there either. Interesting thoughts none the less. Loving your blogs mate. Cheers

        1. No probs Linc, and thanks – glad you’re enjoying it! Couple more thoughts…

          It’s not so much that there’s no cashflow, it’s that there is no return other than that from capital growth. Investing in shares for income, it is always a positive return of 4-5% which you can just choose to reinvest into more shares, plus capital growth. Every year you have more and more accessible cashflow which you can choose what to do with. With property you mostly have negative cashflow, but an asset on your balance sheet that may or may not have increased in value – one is paper net worth, the other is paper net worth plus income. So you’re receiving both elements of return.

          I didn’t appreciate the negative aspects of property or the positive aspects of shares when I started, but now with a little bit of experience, I feel like I know enough from both sides of the argument to form a reasonable opinion on what makes the most sense in the context of reaching FI quickly.

  22. Looking at starting out on my shares Lic’s adventure.
    what should I read?
    Are there any basic shares and Lic’s I should start out with
    Buying Aussie shares and Aussie Lic’s only
    Regards Len

    1. Hi Len, great stuff.
      You might like to check out my LIC reviews page here
      Any of those companies are suitable (in my view) for people wanting to start investing in shares, especially who want a solid and reliable income stream. All the best on your new path 🙂

  23. Do you really think 700-800K is sufficient to maintain retirement without drawing down?

    Putting aside for a minute that retiring early on 41K seems quite unrealistic for most families i.e. if you have to pay for a residence, have children living in your home for 20 years, some kind of basic life cover to support your dependents if something happens to you, want to travel (perhaps other than to Bali), have dental bills, upgrade your cars at least once in 10 year period, etc etc

    More to the point, if your shares drop 25 to 50% in value and recover slowly over 10 years, particularly at a recovery rate that isn’t steady, you will eat through your 2 years of reserve cash. Then how do you plan to build up your reserve cash for the next cycle?

    are you old enough to have lived through a cycle as an adult? because generally it’s the worst time to get any kind of work… most people who have been out of work for a long time find it hard to find a job in good times, let alone at their worst.

    1. Hmm there’s quite a number of complaints to address in this comment, but I’ll give it a go. It sounds a little defeatist and like you’re operating from a mindset of scarcity.

      Is $800k enough to live on? Well it depends. We currently spend $45k per year and that’s including rent and a number of optional expenses we could easily cut down on. $800k in Aussie LICs currently pays around this level of gross dividends with almost no tax to pay. Then you need a cash buffer/backup plan as well. People need to decide for themselves what level of spending they want in retirement and therefore how much they need in net worth to retire. That’s not up to me, that’s an individual thing. People live on a lot less than you might think, especially if they’re away from the big cities. So I’m never suggesting here’s what everyone should do, more like here’s what’s possible, but do what you want. Life can be as expensive (or not) as you make it.

      If your shares drop in value, that doesn’t affect your dividend levels, so it seems you’re missing the point. It’s all about cashflow. If you’d retired on dividends during the GFC and held a few LICs like AFIC your dividends would have barely changed at all, even though prices were down by 50%. Dividends will likely be cut in the next downturn, but if you’re living on $50k of dividends, which gets cut to $35k dividends (a 30% cut), you’d use $15k cash in the first year of the big cut, and then less each year as dividends steadily recovered again as is likely to happen. So you might burn through cash like this – $15k first year, $15k second year, $10k third year, $10k fourth year, $5k fifth year, $5k sixth year, $5k seventh year, $0k eight year recovered. You’ve used $65k cash out of your $100k cash so there’s room for it to be a fair bit worse. This is without reducing your spending or doing anything different whatsoever, which is pretty unrealistic for a time when it feels like the financial world is ending.

      I get that it’ll be harder to find work, but even so, some very minimal part time work is not unlikely. Even one day a week or a fortnight would help to plug any income gap to avoid using the cash buffer. I haven’t lived through a recession and not many working adults have, given it was 28 years ago, you’d have to be nearly 50 to have experienced it.

      But I believe most people are more resilient than they might expect, doing whatever is necessary to make their situation work. People aren’t just going to sit around sobbing watching their lives crumble and do nothing about it. At least I sure hope not. But this blog encourages people to build strong financial habits, and they never leave you, meaning you will be in a position to make any change necessary and see yourself through some scary times. That’s what building financial strength and being a resilient person is all about.

      I’m not promising rainbows and unicorns here – it’s about taking responsibility and realising we have more power and control over things than we think.

      1. That was a great reply Dave.

        Apologies – my question was not intended to be complaints, but more to do with bringing attention to the risks.

        I think for many, 45k is cutting it *very* fine for a couple and not feasible for many if you have kids… and 700 to 800K seems like a bare minimum to me.

        The risk of needing to drawdown when the markets have taken a beating is not a necessary or desirable risk in my view. You might have to put off a big purchase for 5+ years or say good buy to a good slug of your income. Also, no offence, but given that you’re probably young and feel fairly indestructible (as I once did ! :), you may not be sensitised to the very real possibility that one of you passes away… things happen.. not having diversity in your portfolio may mean that you need to un-retire for a while. The timing could be quite uncomfortable and upsetting, or may not even be possible e.g. you both get in a car accident and you are unable to work. This kinda thing happens to people all the time in life, it’s much more common than you think.

        Further to the above, counting on a differential of 2% or more of inflation to dividend yield is pretty risky in my view. Earnings and dividend growth will not necessarily grow indefinitely at the same level above inflation as they have in the past. Inflation may go higher and dividends may be cut for a multitude of reasons, Australia has been extraordinarily lucky to avoid a technical recession for a long time and relying too much on historical data is dangerous.

        My personal preference (not that you asked, buy hey, why not ? 🙂 …I’d rather work and save as much as I can, while I can (and while I enjoy it), at least to the point where risk is minimised… rather than stop when I get to the minimum I think I need to get by.

        1. I appreciate your concerns, but in most cases they aren’t warranted.

          You probably haven’t been around the Financial Independence / Retire Early crowd very long. $45k is perfectly reasonable because consumption is not the goal like it seems to be with most of the population – freedom is the goal and a satisfying life is not the same as an expensive one. It’s about knowing where your money goes, prioritising things and then optimising your costs. Don’t get hung up on one number – everyone gets to choose their own remember!

          No I don’t feel indestructible. I just don’t feel spoilt and entitled to a perfect existence where nothing goes wrong (like many). So I’m personally willing to be flexible and adapt to new environments whatever happens. Diversity in a portfolio isn’t going to do much if one of us dies? We’re both now only semi retired anyway as since reaching FI we’ve both found productive stuff we like to do and so we’re working part time (as most early retirees do).

          This is a common theme. People step away from the full time workforce, have a good break, then start working on/doing things they enjoy, rather than just to earn a wage. Some of that might be paid, some of it not. The point is they are free to do as they please and follow any interests they have, while dedicating as much time to health, family, hobbies etc. as they like. So in truth, most people don’t even need the level of wealth they’ve built up, even though it may not seem overly large.

          I’d like to see the stats on how common that scenario is. A couple is FI living off dividends, they have a good sized buffer, they have a car accident and can never work again, use all their buffer, continue the same spending and then run out of money.

          You don’t subtract the inflation from the dividend yield – you subtract it from your total return. Earnings and dividends need to grow with inflation, and they have throughout history. They don’t need to be perfect every year, but the baseline expectation is company earnings will beat inflation over the long term, for lots of reasons – our future living standards depend on it as a society.

          I’ve already mentioned that Australia will have a crash, you can read that here –

          Part of the reason we decided to quit work so soon is because we knew we wouldn’t sit at home and watch tv while the world goes by. We decided to simply make it work whatever happened and that there are a million ways to be flexible if we run into problems, which I’ll go into in a future post. But for some reason, some people only see the risks and the scariest what ifs, not the opportunity cost of having your freedom a decade earlier. Whereas we see both, and decide it’s worth it. I don’t see the point giving our lives away at full time work for an extra 10 years just for a bit more cushion in case something goes wrong. There’s always a bad scenario that will exceed your level of financial padding, the chance of it happening just gets much smaller.

          I use historical data as an interesting guide to what has happened and then make my own expectations of what I think is a realistic future.

  24. Just thought I would add my 2 cents worth, 45K is a reasonable figure if you own your own home(no mortgage), have no other debts and most people retiring either early or late would not have children/or the children would have left home and be self sufficient . You also have your income split(partner/wife) so there is no tax or very little being paid either.
    All early retirees do that little bit of part time work in most cases and have little extra income sources and to be honest when you retire you get used to living off less and plan more…the amount of money wasted when you have a 9-5 job is amazing. If you have a good share portfolio the share prices rise, the dividends increase and you readjust to keep pace….
    You have to have the courage and mindset to get over not getting that salary every two weeks….once you get over that fear the rest falls into place if you plan right.

    1. Hi Mark or SMA, I see this comment mentioned a few times and would like to seek some clarification:
      You also have your income split(partner/wife) so there is no tax or very little being paid either.
      Does this mean you bought LICs in both of your & partner joint names in order to alit the income for tax purpose? Or this is done via a trust structure? Thanks.

      1. Gday Simo, yep my wife and I buy our LIC’s, other stocks and any investments in joint names for tax purposes. Any tax we might have to pay is offset by Franking Credits so we end up paying nothing. I do a bit of spec investing too on a few growth stocks with a bit of play money so I also try and offset any capital gains tax by selling off under performer’s in the same tax period.

      2. Hey Simo. We also buy our shares in one joint account and one separate account, and are paying very little tax overall, so nearly all franking credits are refunded. No trust structures are used.

  25. Thanks SMA for sharing your this strategy. I myself is currently following the VAS/VEU/VTS slit (currently having 350k split between the three) and after reading this post gives me second thoughts on going the LIC route from now on. Im married with a 3 year old so we got to think this through. I was also inspired by Aussie FireBug and Pat The Shuffler going the LIC route. Thanks SMA again and keep posting.

    1. Thanks for the comment, sounds like you’re well on your way already 🙂

      If you prefer ETFs but like the higher income, you can always just keep adding to VAS which will help you get to a higher level of dividend income sooner. All the best with it!

  26. Hi and thanks for the comprehensive article! If I live in NZ (so am a non resident) are fully franked Aust dividends of less benefit as I don’t get the franking credit . In this case is dividend Investing of less benefit? Am i better off investing elsewhere?

    1. Hi Angela, that’s a very good question. I believe you’ll probably have to pay tax in NZ on those dividends but I’m unsure if the franking credits are honoured or not (doubtful). The issue is, if you invest anywhere outside NZ this is likely to be the case, where tax will be payable on any income earned.

      So I’m not sure you’re better off investing elsewhere, but it’s up to you to decide. Are Australian shares still attractive with a yield of 4-5% plus growth compared to the alternatives? I’d say that’s still a pretty good starting point, especially given it’s still a form of low cost local investing (we’re neighbours after all).

      But equally you could invest in an NZ dividend paying fund, though from what I’ve read this is likely to be less diversified than Australia. Hope these thoughts are helpful.

  27. Chiming in late here. I’ve been investing through a number of different strategies and chasing dividends always seems to bring the best long term returns. The franking credits really make it a no-brainer and I think there are a few benefits that you might have missed. Obviously investing in ASX rather then overseas growth stocks means that you aren’t exposed to currency risk. Especially given what has happened to the AUD in the past 12 months. Dividends also slowly derisk an investment. If you invest $1,000 in some high growth startup that isn’t paying dividends and after 10 years the business fails you lose everything. If that $1,000 went into a boring local business paying a 5% yield that also fails after 10 years then you’ll manage to salvage $500 from your investment. When I was running my own business we’d often talk about paying a dividend to ourselves simply to ‘take some money off the table’. I don’t see why investing should be any different.
    Finally, I’m not sure that the reason why Australian companies pay dividends is that they are low growth and ‘boring’. I think there’s a lot of fantastic businesses in this country that operate with near monopoly power. It’s a sign of strong health that companies like Sydney Airport, the banks, BHP etc can return so much surplus cash to shareholders. I think it all provides a profitable and low risk path to FIRE that Australians are lucky to have. Nice article 🙂

    1. Thanks for your thoughts Adrian.

      You’re right about currency and I summed up that and a few other things in this accompanying post Though overseas investments would have benefited from the AUD falling so I’m not sure that’s a negative (but it goes both ways). My main concern is our investment income would then be volatile which isn’t ideal for those taking an income focused approach.

      Interesting perspective on paying dividends as de-risking an investment, I can see how that’s an advantage. It’s true that strong dividends are generally a sign of strength and profitability, though the truth is our banks growth outlook is slow, and dividends are the choice of returning cash back to shareholders rather than buybacks in the US. I’m happy to take the cash as it can be easily wasted inside the company, so it instils some discipline into management, rather than thinking they have all this free money to chase growth with and go empire-building!

      Cheers Adrian 🙂

  28. Hi Dave,

    I have just come across your blog and would like to thank you for the awesome content.

    The idea of dividend investing is becoming more appealing to me the more i learn about achieving. The one question i have however is at the beginning of the FI journey if one invests heavily in dividend ETF’s/LIC’s then would that no slow the compounding rate of the total investments as one would have to pay tax all the dividends before they are re invested, instead of having a more growth approach which would keep the investments compounding overtime.

    1. Hey Oliver, welcome and thanks for the feedback!

      Yes, technically dividends are taxed more than capital gains, but there’s a little more to it than that. Franking credits typically go along way to paying the tax payable on Aussie dividends. Also, even if you’re investing for growth with a more global portfolio, there is still dividends coming in and tax to pay on that income, which comes with no franking credits attached. So often Aussie and international shares are losing the same amount of returns to tax. Simplified example…

      Global shares dividend yield 2.5%. Less 40% tax. = 1.5% net yield. So 1% return lost to tax.
      Aussie shares dividend yield 4%. (franking credit value 1.5% = gross yield 5.5%). Less 40% tax. 3.3% net yield. 0.7% return lost to tax.

      So tax on dividends in Australia is not as bad as it’s made out to be sometimes. This post might be of interest – https://www.strongmoneyaustralia.com/tax-efficient-dividend-investing-dssp/

      That said, for me it’s not about the highest yield. Growth is important too, as I wrote about here – https://www.strongmoneyaustralia.com/invest-for-dividend-growth/

      International shares provide some excellent diversification, just come with a lower dividend yield, but should have higher growth. A combination of both is the most diversified option and can still produce decent dividends overall. But it’s a personal choice. Anyway, hope this stuff helps Oliver.

  29. So many comments on this post I couldn’t read them all so sorry if this has been mentioned…

    You might want to consider UMAX for US exposure. It’s a betashares fund that buys the s&p500 index and sells covered calls to generate income. Yield is almost 6% (unfranked obviously). You miss out on a bit of growth when the us market is strongly rising but should do a bit better in a bear market.

    For me UMAX overcomplicates things but It might suit some who want the income and don’t mind missing out on some of the boom growth. So far it has slightly underperformed the index but the us market has been growing strongly so that is not surprising.

    1. Thanks for the suggestion Simon.

      I’ve looked at UMAX before, and for whatever reason (probably the options strategy or costs or variable income) I didn’t like it. The yield is decent but I’d prefer to keep it simple and just accept the US market for what it is. Also I’m not convinced in Betashares managing it all that well (or an issue with the strategy) as when I was looking at it the US market falling, yet the fund was still continuing to underperform (which is the opposite of what they imply will happen in flat/down periods).

      It might work well in some folks portfolios, but I’m not sure about it.

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