Canny View: Living off dividends in retirement is 'uncertain strategy'

The pressure to cut dividends is because lower profits make dividend payments less affordable. Photo / Getty

The coronavirus-induced economic downturn is taking a toll on a popular source of investment income for retirees: dividends.

A dividend is a payment from a company to a shareholder who has invested in shares of the company. Publicly traded companies that offer dividends usually pay them on a fixed schedule, and the amount given out to shareholders is based on the company's profit and performance.

The eligible shareholders will receive their dividends in the form of cash or occasionally additional company shares. Generally, a company's ability to pay dividends is a sign of good corporate health.

Many investors and retirees rely on their investment portfolio to fund their cash needs. It is a popular approach that investors often consider to accomplish their cashflow goal from an investment portfolio that is heavily focused around dividend-paying stocks. Dividend stocks through their nature are typically not growth-focused and are frequently termed as value stocks.

Dividend stocks are a staple of every income investor, and they can play an important role in any portfolio, regardless of age and financial circumstances. Particularly in recent years, as term deposits yielded next to nothing, dividend-paying shares offered some relief to investors both in terms of capital growth and stable dividends.

But, living off dividends in retirement is becoming an uncertain strategy now, especially in the current environment marked by a pandemic, economic upheaval, companies announcing profit warnings and extremely low bond yields.

Analysts say dividend payments are going to decline sharply this year – they could drop by 30 per cent or more globally, similar to what was seen through the Global Financial Crisis.

During the GFC meltdown in 2008-09, major companies in the world slashed or eliminated their dividend payments. These companies were known for consistent, stable payments each quarter for literally decades and more. Despite their legacy, many dividends were cut.

Nick Stewart - In New Zealand, analysts say the dividend hit will be evident over the next 12 months based on the cash reserves reported by the companies in February 2020.

The pressure to cut dividends is because lower profits make dividend payments less affordable; globally some governments want some larger firms (those who sought government support during Covid-19) to cease dividends and preserve their cash and capital reserves.

It is important to understand that the dividend payments to the shareholders are always based on business-as-usual with strong profits – which may not be currently happening or expected to in the foreseeable future.

Currently, in the United States, as the pandemic continues to rage, many companies are dealing with heavy revenue losses and are forced to cut expenses.

In March 2020, the cuts announced by US companies have reduced the total dividends expected from the S&P 500 this year by almost US$10 billion ($17.5b). And, that number could grow going forward with the economic uncertainty.

In New Zealand, analysts say the dividend hit will be evident over the next 12 months based on the cash reserves reported by the companies in February 2020.

To name but a few New Zealand companies with cancelled dividend payments are Auckland Airport, Tourism Holdings and Fletcher Building.

Closer to home, Napier Port's board decided against paying an interim dividend citing "short-term impacts and long-term risk associated with Covid-19".

In the banking sector, the Reserve Bank imposed an indefinite dividend ban on all the New Zealand banks (including the Australian owned banks ANZ, BNZ, ASB and Westpac with local subsidiaries, many of which are widely held by investors in New Zealand) to support the stressed economy and households.

During this current crisis, many listed companies, including Auckland Airport, Kathmandu, Sky TV, The Warehouse and Vista have raised fresh equity to strengthen their balance sheets.

One example is on June 17 Sky City announced its plan to raise $230m in new equity and for dividend-focused investors, a capital raising at a discount to the share price would have been the last thing on its mind. Their strategy is receiving cash, not parting with it.

On the other hand, investors not taking part in a capital raising may experience a dilution of their shareholding. For example, NZ Rugby Union's 5 per cent holding in Sky TV has shrunk from $22m, just after it inked its five-year broadcast deal, to $4.2m.

A substantial decline in its investment after not participating in the recent capital raising.

So, it is very much possible that dividend investors can fall into the trap of hindsight bias if they are not careful and sufficiently diversified.

At the same time, it is equally important to ease the stress retirees and investors are facing on all fronts to build a consistent income stream in the current times that will last their lifetime.

We always consider that proper diversification is one of the golden standards of an investment portfolio.

If an investor goes all-in on dividend stocks for retirement, he/she would be concentrating entirely in one asset class and investment style.

Investors need to understand how much risk they are willing to tolerate, and the rate of return that can reasonably be achieved.

While each of us will ultimately reach different conclusions and asset allocations, we all have some common goals – to maintain a reasonable quality of life in retirement, sleep well at night, and not outlive our savings.

But with any investment decision, be sure your financial adviser is only looking after your best interests and is disclosing the total fees, and fine print of the investment strategy you are considering.

· Nick Stewart is an Authorised Financial Adviser and CEO at Stewart Group, A Hawke's Bay-based CEFEX certified financial planning and advisory firm. Stewart Group provides personal fiduciary services, Wealth Management, Risk Insurance & KiwiSaver solutions.

· The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961 or visit our website, www.stewartgroup.co.nz