Does over-reliance on bank dividends threaten your annual income?

When it comes to investing in Australia’s banks, old habits die hard. Despite the recent challenges confronting the sector, and mounting evidence that their halcyon years are behind them, too many income investors still regard the big-four as a suitable surrogate for fixed income.

Given that the mouth-watering dividends investors previously banked on now look decidedly less certain, it’s right to question whether Australia’s multi-decade obsession with listed bank stocks is still warranted. If declining future earnings are anything to go by, then historically high dividend levels appear unsustainable.

Time to look beyond uncertain bank yields

If you’re a self-funded retiree who’s treated bank dividends like annuities, it’s time to review how exposed your annual income is to any serial downturn to their historically high payout ratios. Unlike the global financial crisis, the banking sector, and especially the big-four, will not emerge from the Coronavirus unscathed.

The $64,000 question for investors is whether it’s still worth holding banks if they’re neither growth stocks, nor income plays? Admittedly, investing in a single bank has previously provided some capital growth as well as yield. However, future growth opportunities for bank stocks are looking even more challenging than in years past.

Bank dividends may still outperform miserable term deposits (at sub-1%). But with shareholders likely to receive either a much lower interim dividend or no dividend at all – due in part to the high bar that’s been set by the prudential regulator, and lower profitability – placing too much faith in income from a single bank stock is now a lot riskier.

Earlier this year the Australia and NZ Banking Grp Ltd (ASX: ANZ), and Westpac Banking Corp (ASX: WBC) deferred their dividend completely, and Macquarie Group Ltd (ASX: MQG) paid a dividend 50% lower at $1.80. Meantime, National Australia Bank Ltd. (ASX: NAB) paid an interim dividend of 30 cents, down 64% on FY19.

Then there’s the Commonwealth Bank of Australia (ASX: CBA), which recently slashed its final dividend by 31 percent lower than previous years, in response to an 11 percent drop in net earnings from the year prior.

The power of diversification

The recent fall in dividend payout ratios reminds all investors of the need for diversification away from reliance on yield from a single asset, whether it’s income from a term deposit or a dividend-paying bank stock.

But despite the deep cuts to bank dividends, it’s important to remember that up to 95 percent of the top-100 ASX companies still have greater yields than 12-month term deposits. One way to tap into these, without buying the whole market, is through one of InvestSMART’s blended ETF portfolios.

It’s true, there’s more risk associated with owning an InvestSMART ETF portfolio than a low yielding (government guaranteed) term deposit. However, due to their built-in diversification, there’s less risk in owning any one of the InvestSMART’s ETF portfolios – from Conservative through to High Growth – than placing all your income expectations on one or two unpredictable dividends.

The risk is offset because you’re no longer putting all your eggs in one basket. A carefully chosen selection of ETF’s within an InvestSMART portfolio, exposes you to more upside than a single asset. Based on the ETF’s we’ve chosen, the focus is not solely about achieving an extra percentage of yield.

Time to explore a total returns approach

That’s why InvestSMART’s four ETF portfolios are more focussed on total returns than just dividend yield. InvestSMART adds to your wealth by capturing the dividends in the cash component on the portfolio, and then using it to buy more holdings when the portfolio is rebalanced. You’ll also reap the benefit of compounding returns.

By taking a total returns approach, InvestSMART maximises the overall return of your portfolio, rather than simply preferencing income over growth, while also reducing the risk of capital loss.

We do this by allowing capital gains to supplement the income generated elsewhere within our portfolios. One of the other benefits of total return investing is that it provides better control over the size and timing of withdrawals, and InvestSMART withdrawal options help you set this on autopilot.

With an InvestSMART ETF portfolio, you also get to decide how much and how often you take cash, rather than waiting for a schedule of underwhelming dividend payments.

 Find out more about InvestSMART diversified portfolios here.