Higher returns mean higher risk

BY MARY HOLM

Q: My husband and I are now in retirement and consolidating, and are contemplating buying a few parcels of shares.

Upon researching the way to go about it, we are nearly always told that such and such a share is not good, and our informant nearly always means that the purchase price is fluctuating to a lesser or greater extent.

We realise ordinary shareholders are the first victims to fall on the economic battlefield. But very few people bother to point out that the dividends payable are, quite frequently, on a rate which tops bank deposits and suchlike by very reputable and highly regarded listed companies.

Why is it that so many people emphasise capital growth or capital shrinkage and forget about the dividends?


A: Because dividends can be cut, sometimes quite drastically.

A few years ago, for instance, Telecom cut its dividends from 90 per cent of profits to 50 per cent.

Telecom shareholders who relied on the dividends for regular income were hit hard.

And other companies no doubt feel pressure to follow suit.

New Zealand companies pay peculiarly high dividends by world standards. Our average dividend yield, of around 6 per cent, compares with about 3 per cent in Australia, 2.5 in the UK, and 1.2 per cent in the US.

Various commentators have pointed out that New Zealand dividends tend to be too high.

If companies kept more of their profits for reinvestment, rather than handing them out to shareholders, their businesses would grow faster. This would boost share prices, to the benefit of shareholders.

Having said all that, if you invest in, say, 10 or 15 shares that tend to pay high dividends, it's unlikely that your total dividend income would suddenly drop all that far.

And, if you didn't like the way things were going, you could always sell the shares and move back to term deposits.

The trouble is that, at that stage, the share prices might be doing the capital shrinkage you've been warned about.

As Milton Friedman said, there's no free lunch in investment. Higher returns mean higher risk.

If you've got plenty of assets behind you and other secure sources of income, you might be willing to take the risk.

But I wouldn't recommend that a retired couple should rely on dividends as their main source of income.


* Mary Holm is a freelance journalist and author of Investing Made Simple. Send questions for her to Money Matters, Business Herald, PO Box 32, Auckland; or email: maryh@pl.net Letters should not exceed 200 words.