Register For Our Mailing List

Register to receive our free weekly newsletter including editorials.

Home / 529

Clime time: Why stocks beat bonds for income investors

Over the past 10 years, the S&P/ASX Price Index has delivered meek returns, though the picture improves when dividends are included in the Total Return Index.

The 10-year returns are:

  1. The Price Index return is about 38% or 3.2% annual compound, and
  2. The Accumulation (Total Return) Index is about 110% or 8% annual compound (but before franking).

Following the market correction since mid-August 2023, the capital gain of the market index from when Covid hit in March 2020 is now about zero for the last 4.5 years. The return including dividends that are fully reinvested is a healthier 30% (pre franking) over the entire period. However, this 4.5-year return of about 6.6% per annum is below both our targeted and expected long-term return of 8% per annum.

In reality, the Accumulation Index return is an appropriate measure of the equity market return for an SMSF in 'accumulation mode'. However, it is not a measure of the (longer-term) return for an investor who takes the cash dividend from the market to fund a pension. 

The post-Covid investment cycle

This background leads us to consider the dramatic change in income returns across asset classes that have flowed as the world economy transitioned from post GFC, through Covid and now into a post-Covid cycle.

Projected and actual asset returns drive investment allocation that is also adjusted by the risk profile of the investor (SMSF). Returns from capital gain and income, from all asset classes, will be driven by the investment climate as measured by cash rates, bond yields and the interplay of 'risk free returns' with equity prices measured by Price/Earnings Ratios (PER) and property capitalisation rates.

The world has moved from the post-GFC cycle where the introduction of quantitative easing (QE) to fund burgeoning government debt, plus highly supportive fiscal settings, dominated. Covid checked the anticipated slowdown and the reversal of QE towards quantitative tightening (QT). Indeed, it actually reaccelerated QE, noting it was aggressively introduced in both Australia and around the world. A feature of the Covid era was that most bond yields across the world hovered well below 1% and they were deeply negative in Europe and Japan.

The post COVID era, began during 2022 when lockdowns ceased, ushered in a new investing environment. The era of near zero interest rates is over, and decades of deflation driven by globalisation and demographic changes are being replaced by an extended period of cost-based inflation.

Across asset classes, the most material change has been seen in bond markets. For instance, over the last two years, the yield on an Australian two-year bond has moved from near zero to above 4%. It has been a painful period for passive bond investors with the price of all bonds materially declining. The good news today is that the annual income that can be generated from holding a 'near risk free asset' has become more attractive in nominal terms. But are bonds attractive enough?

Preferring equities over bonds

While bonds can deliver the benefits of diversification in a balanced portfolio, the argument for their role as a key driver of portfolio returns must be framed relative to inflation. Inflation has probably peaked in Australia, yet the most recent CPI release for the June quarter was 6%, still well above the two-year bond yield. Given that government bonds are a fixed income returning assets, their ability to outperform inflation is not currently on offer.

Therefore, a pension portfolio should maintain an appropriate and meaningful allocation to the Australian equity market with the purpose to deliver a growing income stream that is enhanced by franking.

Importantly when comparing Australian equity returns to global market returns, companies here have higher dividend yields. And it is a historical fact that the Australian equity market has delivered total returns, including dividends, that are above most of the developed world. The following chart from the RBA chart book demonstrates this.

Investing in the Australian equity market, like all equity markets, is not without risk. However, with elevated inflation likely to persist well into 2024, equities will continue to play a key role in delivering on pension focussed long-term income objectives and defend against the impact of inflation.

The surging equity market during Covid was driven by bloated PERs due to excessively low bond yields. Post-Covid, PERs have declined but equity dividend payments have risen, while bonds have entered a third year of negative returns.

 

Will Riggall is CIO of Clime Group, a sponsor of Firstlinks, and oversees the Ralton Dividend Builder, available on several leading platforms and Clime Capital, the group’s listed investment vehicle, has been constructed to deliver a high and growing tax effective dividend stream. The information contained in this article is of a general nature only and is current as at the date of publishing. It does not take into account the goals, objectives, or personal circumstances of any person.

For more articles and papers from Clime, click here.

 

3 Comments
Keith Milera
October 05, 2023

I find it fascinating the contrast between the dividend culture here and the buyback/minimal dividend culture in the US. The US has throttled the Aussie market over the past 20 years, yet Australian has outperformed over 100 years. Which country is right? I suppose it depends on the growth opportunities and there may be more in the US than here at present.

Steve
October 06, 2023

I believe taxes are the driver. Dividends and capital gains are not taxed at the same level in the US and we on the other hand have franking credits on dividends. So the US use profits to buy back shares and provide capital gains (shares are more valuable when you shrink the pool) and we are driven towards dividends because of the value of franking credits.
Personally I get frustrated by the near universal inability of Aussie finance outfits to factor in franking when talking total return. Why not a new term (gross return?) to show the true grossed up returns? It's dead simple maths but few bother. The annoying thing is these people claim to be providing information for more informed decisions but leave out a key component. Given dividends are a massive part of total returns in Australia so franking credits also are a large part which any serious publication would feel compelled to factor in?

Philip Rix
October 09, 2023

Totally agree with Steve’s comments! Franking credits absolutely have value to all (at least Australian resident) Investors when ever dividends are paid. Even non residents shareholders benefit as no withholding tax is applicable when dividends are franked.
‘Yes’, publishing ‘Gross’ returns as suggested makes perfect sense!

 

Leave a Comment:

     

RELATED ARTICLES

Clime time: Asset allocation decisions for SMSFs

Investing for generations

Three factors shape whether we are at the bottom yet

banner

Most viewed in recent weeks

An important Foxtel announcement...

News Corp's plans to sell Foxtel are surprising in that streaming assets Kayo, Binge and Hubbl look likely to go with it. This and recent events in the US show the bind that legacy TV businesses find themselves in.

Welcome to Firstlinks Edition 581 with weekend update

A recent industry event made me realise that a 30 year old investing trend could still have serious legs. Could it eventually pose a threat to two of Australia's biggest companies?

  • 10 October 2024

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

Welcome to Firstlinks Edition 578 with weekend update

The number of high-net-worth individuals in Australia has increased by almost 9% over the past year, and they now own $3.3 trillion in investable assets. A new report reveals how the wealthy are investing their money.

  • 19 September 2024

The everything rally brings danger and opportunity

Most market players today seek quick rewards and validation of opinion. Outsiders willing to combine new technology with old-fashioned patience and focused analysis can prosper.

Creating a bulletproof investment portfolio

Is it possible to build a portfolio that performs well in any economic environment? So-called 'All Weather' portfolios have become more prominent of late, and this looks at what these portfolios are and their pros and cons.

Latest Updates

Retirement

The quirks of retirement planning with an age gap

A big age gap can make it harder to find a solution that works for both partners – financially and otherwise. Having a frank conversation about the future, and having it as early as possible, is essential.

The everything rally brings danger and opportunity

Most market players today seek quick rewards and validation of opinion. Outsiders willing to combine new technology with old-fashioned patience and focused analysis can prosper.

Investment strategies

Portfolio construction in the real world

Building a portfolio is like building a house. This framework can help you move towards your goals without losing sight of reality or leaving yourself vulnerable to market storms.

Shares

Feel the fear and buy anyway

In this extract from his new book, the co-founder of Intelligent Investor reveals how investors can avoid critical mistakes and profit from opportunities in collapsing share prices.

Investment strategies

The risks of market concentration and not staying invested

MFS chief investment officer and CEO elect Ted Maloney talks market risks, similarities between Trump and Harris, and the most important thing investors can do to avoid destroying value.

Gold

Gold's important role as geopolitical tensions rise

Equity markets have traditionally struggled at times of sustained geopoltical tension. Gold, on the other hand, has thrived and can provide investors with protection against "unknown unknowns".

Strategy

The changing face of finals footy and the numbers behind it

A well-meaning AFL rule change in 2016 seems to have had unintended consequences. The top teams might cry foul but AFL bosses are unlikely to be too miffed about the outcome.

Sponsors

Alliances

© 2024 Morningstar, Inc. All rights reserved.

Disclaimer
The data, research and opinions provided here are for information purposes; are not an offer to buy or sell a security; and are not warranted to be correct, complete or accurate. Morningstar, its affiliates, and third-party content providers are not responsible for any investment decisions, damages or losses resulting from, or related to, the data and analyses or their use. To the extent any content is general advice, it has been prepared for clients of Morningstar Australasia Pty Ltd (ABN: 95 090 665 544, AFSL: 240892), without reference to your financial objectives, situation or needs. For more information refer to our Financial Services Guide. You should consider the advice in light of these matters and if applicable, the relevant Product Disclosure Statement before making any decision to invest. Past performance does not necessarily indicate a financial product’s future performance. To obtain advice tailored to your situation, contact a professional financial adviser. Articles are current as at date of publication.
This website contains information and opinions provided by third parties. Inclusion of this information does not necessarily represent Morningstar’s positions, strategies or opinions and should not be considered an endorsement by Morningstar.