KEY POINTS:
This time last year you could get an 8.25 per cent annual return just by parking your money in the bank.
Eight months after Reserve Bank governor Alan Bollard began slashing the official cash rate bank deposit rates are down to 5 per cent, and after another 150 basis point cut this week interest rates are expected to fall further.
For those who have become used to putting their money in the bank to earn an income it has become a challenge to look for safe alternatives.
"People are being forced to come out of their comfort zone," says Spicers senior financial adviser Jeff Matthews.
New Zealanders aren't alone in facing the issue. Around the world central banks have cut rates, forcing commercial banks to drop their rates.
In the US the Federal Reserve rate is down to virtually zero, while the Bank of England has dropped its rate to 1.5 per cent.
Australia's Reserve Bank rate is still sitting on 4.25 per cent but analysts say the market is expecting it to fall to 2.25 per cent.
"We're still pretty high compared to what people in other countries are getting," says Matthews.
But the fact remains that Kiwis have been used to getting a good income for very little risk.
"In my mind people have been rewarded for taking no risks. Logically if you look at the different asset classes cash should earn you the least amount of money, followed by fixed interest and then property and shares.
"That is the normal order but that is not what has happened here."
The fall in deposit rates was a situation Matthews recognised last year when he began to move clients' money into corporate bonds.
Matthews says up until last September corporates were offering annual interest coupons of more than 9 per cent.
But now corporate bond rates have fallen by around 2 per cent, he says, listed company shares with high dividends are looking attractive to income investors again.
"Share prices are off 50 per cent but companies are still paying dividends."
He admits dividend payments are likely to come under pressure this year but says many will still produce a lot better yield than money in the bank. "This year is going to be tough. But you are still going to be way, way better off than keeping money in the bank."
Matthews says not only can shares provide a strong dividend but in the long term they offer strong potential for a capital gain as share prices lift again.
Brook Asset Management fund manager Chris Gaskin believes there are only two real choices for those looking to beat the bank rates - corporate bonds and shares paying dividends.
He firmly believes that share dividends offer a better opportunity and now is the right time to be getting back in.
"Bonds such as the recent issue by Auckland Airport provide attractive yields relative to cash but why buy the bond on a 7.25 per cent yield when you can buy the equity (and the claim to future cashflows) and receive a 7 per cent gross yield in the meantime for your trouble?"
Stephen Bennie, a fund manager at NZ Funds who specialises in investing in companies with dividends, says many New Zealand companies offer good dividends because they are mature companies with strong cashflows.
On top of the cash dividend, New Zealand investors can also get the tax paid by the company on the dividend rebated through imputation credits which pushes the yield up even higher.
The highest yielding share at the moment is listed property trust ING which is offering a gross yield of 17 per cent - although Bennie says the high level is an indication that dividends are likely to drop because the property fund has high levels of debt.
Others in the listed property sector are also attractive, he says, like the Goodman Property Trust.
It is paying 10 cents per unit and once the imputation rebate is taken into account a 33 per cent taxpayer could get a gross yield of around 15 per cent.
But he admits some company dividends are likely to be at risk this year.
"When earnings [fall] and the pay-out rate has been high, you have really got to cut the dividend."
But he says even if dividends do drop they will still provide a better return than parking money in the bank.
"Some could drop 10 per cent and you would see better than cash returns. We see quite a lot of buffer in the yields we get."
The upcoming reporting season in February and March is expected to provide some guidance from companies on where dividend levels will go.
He says those looking for a strong dividend should look for companies with strong balance sheets and low levels of debt relative to earnings.
"You want companies with cash on the balance sheets, you certainly want to see a minimum level of debt and also long maturing debt - you don't want to have a big re-finance this year."
Companies to avoid are those in a growth phase which do not pay any dividends or those which have high levels of debt and are likely to have to cut their dividend.
But First NZ Capital head of fixed interest Graeme Beckett believes conservative investors - like those who normally put their money in the bank or in fixed-interest bonds - are unlikely to switch into high dividend shares.
"In my experience it is relatively seldom we see someone who has typically been a bond investor revert to equities as an alternative income source.
"They want the certainty of the income and the certainty of the capital return. Equities do not provide either. Bonds might not either but that is the expectation."
He says dividends are discretionary and at the whim of the board they can be changed or eliminated.
"The investor has no control over that - the only way to get your money out of equities is to sell your shares.
"If you are a risk-averse investor who has had comfort in the bank, switching to shares, it's just not going to happen."
Others say investors need to be very cautious when it comes to investing for income in shares.
"Stocks that are offering high dividend yields should be viewed with extreme caution," says PIE Funds fund manager Mike Taylor.
"A company on a high yield probably indicates the business is under stress and the market is telling you that last year's dividend or the broker's forecast is not reliable.
"Investors would be better to wait until there is some stability in the market and the economy."
BANK RATES
* Highest rate on a bank on-call savings account is 6 per cent at TSB Bank for a balance over $100,000.
* Highest rate for a minimum deposit of just $1 is 5.4 per cent on the RaboPlus (Dutch Rabobank's online savings business) esaver account.
* Lowest rate is on Westpac's earner account for $5000 at just 0.75 per cent interest. Source: interest.co.nz
WHAT ARE CORPORATE BONDS?
* Corporate bonds are issued by a company wanting to borrow money for a set amount of time.
* They pay interest to investors at a set rate per year and are then paid back at a set time.
* The risk of lending your money to the corporate can usually be judged by its credit rating from international companies such as Standard & Poor's and Moody's.
* Triple A is the best while anything less than triple B is considered to be junk. They also come in secured and unsecured, where the rate is usually higher.
* Upcoming bond offers include Fonterra, Auckland City Council and Trustpower.
