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SMSF Investment Strategy #2 – Generate Your Own Dividends
Many people buy stocks for their dividends, which is a pretty solid strategy for super self-directed funds (SMSF), especially if your plan is for your super fund to provide you with income when you retire. In the Australian market, bank stocks were the favorite of investors looking for dividends. Many financial planners advocated buying bank stocks at the end of 2008 because they were generating dividend yields of close to 10%. The only problem with this advice was that dividends are not guaranteed and are usually a percentage of profits. If earnings go down, dividends usually go down too, so buying a stock just because the dividend yield (based on historical dividends) looks attractive isn’t really a good idea. This has certainly held true for bank stocks, as banks have since cut dividends as profits have fallen and they have also had to keep more of the profits to deal with possible bad debts.
For me, I’d rather generate my own “dividends” than rely on the company to provide me with the dividends I want. First, I would look for stocks in relatively recession-proof sectors like consumer staples, utilities or telecommunications rather than financials. With the banks, we still don’t know how many more loans will go bad due to escalating unemployment and business bankruptcies, or how many new capital raises they will have to do, which will dilute existing shareholders. A stock I’ve been watching for a while is Telstra (TLS), Australia’s largest telecommunications company. When the shares were trading in the $3-$3.30 range, the dividend yield is around 8-9%. As this dividend is fully freed, ie already taxed at 30%, the yield is easily greater than 10% for SMSFs which only have to pay a tax of 15% instead of 30%. Although I love the telecommunications industry, I was hesitant to buy Telstra before because I didn’t feel comfortable with the former CEO and his management team. Although it’s still early days, I like what I’ve read and heard about Telstra’s new CEO. A stock pricing service I use also priced the stock at $3.09, so I’m comfortable buying the stock at $3.00 or less.
In June 2009 I decided to sell Telstra Aug09 put options at $3.12 for a premium of $0.20. If Telstra’s stock price is below $3.12 on August 27, 2009, when the options expire, I would have to buy the stock at $3.12, but the net cost to me would be 2, $92 (3.12 – 0.20), which is a price I’m happy to pay for this action. If Telstra’s dividends stay the same, I’ll get a 10% return on my money, which is better than current interest rates. However, I don’t count on Telstra to maintain this level of dividends even though they have done so for the past two years. Since Telstra is an option stock, I can very easily write call options to get that 10% income even though Telstra pays no dividends that year. My current plan is to sell call options to generate 10% revenue and assuming Telstra continues to pay the 28 cents in fully franked dividends, I could achieve a total return of 20% or more per year.
I am also continuing this strategy with a few other recession proof stocks like Woolworth and CSL which are optional. My outlook for the Australian economy for next year is for little or no growth. I hope the worst is behind us, but even then I expect corporate earnings, even recession-proof companies, to stagnate, so I’m not expecting much in terms of capital gains for those shares. Capital gains would be a bonus, but I rely on the company’s dividend yields as well as the dividends I generate myself by selling options on those stocks.
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