Today, Westpac is paying 1.1% term deposit to clients and 9.25% to its shareholders . . . Search for a higher income is heating up and looks like will be here to stay for us for years to come.
Over the past two months the Reserve Bank of Australia has cut interest rates from a then record low of 1.5% to a new record low of 0.75%. This may be good for borrowers but where does it leave savers? Unfortunately, the days of earning a respectable return in a bank account are now over with the majority of bank interest rates below the official inflation rate. This is an important inflection point as you’ll soon discover.
The most recent inflation rate according to the Australian Bureau of Statistics is 1.6% p.a. which is the hurdle that any investment has to exceed to produce a real increase in purchasing power. Because inflation represents the rate at which economy wide prices are rising, a return of less than the inflation rate means that the real purchasing power of the investment will have declined even if the dollar amount has increased. Committing your money to a bank, in the form of a term deposit, can often earn better interest rates than a typical transaction or savings account. We have therefore gathered information about the current one-year term deposit rates on offer from the big four banks and compared them to the current inflation rate. The best rate we could find came from the Commonwealth Bank (CBA) which was offering 1.35%, and this, of course, is before tax. This means that even a tax-free investor would be suffering a purchasing power decline of 0.25% per annum at the current inflation rate. If this investor continued to roll over the term deposit for the next ten years, and everything else remained the same, the investor would lose 2.4% of their purchasing power despite the account balance increasing every year.
Now given this, what are the options for an investor to avoid this ‘inflation tax’ and produce a real increase in purchasing power over time? A fundamental tenet of investing is that in order to produce a higher return we need to take more risk and that applies in this case. One option is to look at investing in bank stocks. The value of the principle will certainly be more volatile than money in the bank (i.e. riskier) but the returns can be substantially higher and the big four banks are generally considered to be some of the safer stocks on the ASX. The table below compares the gross (including franking credits) and net (excluding franking credits) dividend yields for the big four banks alongside the corresponding term deposit rates. The gap is huge, particularly for the highest yielding bank, Westpac Bank (WBC), which currently has a gross dividend yield of 9.25%, far above the current inflation rate.
|1-Year Term Deposit Gross Income||Dividend Yield (Gross)||Dividend Yield (Net)|
This may tempt readers to consider investing in one or all of the big four banks to obtain these dividend yields but from a diversification point of view this may not be the smartest option. Each of these four banks are relatively similar to each other and therefore even investing in all four does not provide a whole lot of diversification. To get around this problem, Rivkin offer investors a Blue Chip portfolio that invests in the ten of the highest dividend yielding stocks in the ASX 50. This provides a portfolio that is both high yielding and diversified. The portfolio is checked monthly for the need to rebalance but on average we only actually trade this strategy three times per year.
For readers today we are giving access to this portfolio for free for a period of three months. This will give you access to the current portfolio holdings as well as notify you of any rebalances we do over this time.
(Source for the above interest rate table is the respective banks website on 1st November 2019)
*Investing in stock market carries financial risk. Historical performance of a stock or dividend yield does not guarantee future performance or yield. Before investing your money understand the risks of the product you are investing in.
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