While there are a handful of actively managed equity income funds in the market, many are not optimally designed to meet the needs of a retiree. This article explores the role of equity income (through dividends) for those in or nearing retirement.
Increasing dividend yield is important
Dividend yield is a way to measure the cash flow received for each dollar invested in an equity position - in other words, the income return from dividends. For a retiree, it can be argued that the best way to increase income from equities is to increase dividend yield, rather than drawing down on capital.
There are two key reasons for this:
- Franked dividends are more tax effective for a retiree than capital gains;
- The dividend yield on equities is far more predictable and reliable than capital returns.
As such, equity products designed for retirees should be focused on increasing dividend yield. While the prices of equities fluctuate in capital value in the short-term, the success of equity income investing is about focusing on the income stream that a high-quality dividend-paying company can provide. Short-term market fluctuations are not an issue if retirees receive adequate income for life’s everyday expenses.
We are lucky to live in Australia which, on the whole, offers higher dividends than global counterparts. In addition, Australian equity investors benefit from imputation credits, a type of credit that allows Australian corporates to pass on tax paid at the company level to shareholders, which effectively can be used to reduce income tax paid on dividends and can ultimately gross-up the dividend yield of the Australian Stock Exchange (ASX).
Equity funds need to become more goals-oriented
The majority of equity funds are still designed to maximise returns with little or no focus given to income generation. In this way equity product design must move away from the traditional risk/return focus to a more goals-based approach, with the needs of the retiree at the centre. Equity product design must evolve to better meet the needs of retirees. For more information on this approach, visit the Goals-based investing page.