Franked Dividends – A Free Lunch?
Jul0
Do-It-Yourself investors skew their investment portfolios towards shares that pay franked dividends. This is especially prevalent amongst trustees of SMSF’s who appear to over value the worth of dividend franking credits.
Franked dividends are considered by many to provide a “free lunch”. Consequently, fully franked shares are overweight in the investment decision process.
We believe investors should not favour particular shares simply because they pay franked dividends. The usual thinking behind such behaviour is, in our view, flawed.
The Four “Myths” about Dividend Franking
Consider the Four Dividend Franking Myths below:
Myth 1: Higher franking dates suggest better future stock performance
Analysts believe a company’s share price is driven mostly by the stock market’s assessment of its after-tax profit. If they are right, then choosing one company’s shares over another based on current franking levels alone does not make sense.
Myth 2: Franking benefits low rate taxpayers
Some low tax rate shareholders (e.g. self managed super fund trustees) believe they get a better relative advantage (compared to higher rate taxpayers) as a result of receiving franked dividends.
Although there is no doubt that they receive an absolute advantage as a result of their lower tax rate, this will be the case regardless of the level of franking.
Myth 3: Markets incorrectly price the benefit of franking
It’s often suggested that shares offering fully franked dividends provide a benefit not available from unfranked shares. We hope that the above discussion will cause those with this point of view to reconsider.
However, even if you remain unconvinced by that discussion, it is unreasonable to expect that the share market would remove any such arbitrage profit opportunites.
Stock markets are extremely efficient. They rapidly incorporate all known information and biases into share prices. The franking level of shares is well known and any benefit (real or perceived) is almost certainly already reflected in prices.
A rational investor would be prepared to pay more for the franked share compared with the unfranked share. Fund managers will continue to pay up for any franking benefit until the higher price exactly offsets the benefit.
Efficient stock markets adjust to remove any arbitrage opportunities or “free lunches”.
Myth 4: A smart super investment strategy – fully franked, high yielding Australian shares
An investment strategy that emphasises the level of franking is also likely to focus on higher dividend paying shares, to maximise the perceived benefit.
In addition to defying other elements of a sound investment philosophy, such an approach implies an expectation of higher income and lower growth returns, effectively ignoring the relative tax advantage of capital gains tax over income tax.
Capital gains tax offers better opportunity for tax management than franking. Tax can be discounted and deferred (sometimes indefinitely) to reduce the overall tax rate.
The franked dividend investment strategy is misguided…
An investment strategy based predominantly on exploiting the perceived advantages of fully franked shares is naïve.
While franking should be a consideration, as a driver of investment strategy it ignores the importance of the primary variables in the portfolio construction equation – risk, liquidity, costs and a comprehensive tax approach.
An investment strategy that considers these broader issues is far more likely to meet your long term requirements.
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Professional options and Forex trading from your den? Here’s how.
Dec0
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Investing in Gold to Balance Your Portfolio
Jul0
In times of economic crisis, some investors turn to gold as an investment hedge (a sort of financial “insurance”) to protect their investment portfolios. That makes a lot of sense today, given the current value of gold.
Gold as an investment will rarely lose it’s value and will help add stability to your investment portfolio. That is why investors have traditionally turned to precious metals in times of widespread financial woe.The lustrous shine will always shine brightly.
Considering the current financial climate, one might consider if it is a good time to buy gold. Even people who have very small or nonexistent investment portfolios are considering purchasing some gold.As Gold prices continue to skyrocket is seems pointless not to have a small investment?
Unfortunately, there is no straight answer to that question. For some people, now is absolutely the time to buy gold. For others, it is not a good time. So how do you know if it is a good time for you to buy gold?
Do you have a significant amount of consumer debt such as credit card balances or car loans? If so, you would be better off applying any extra money you have to your debt. Are you overly concerned with the short-term performance of your investment portfolio?If this is the case, then it may not be a commodity for you. This is because gold does not generally have a good return.
“How can that be?The price of gold is high! If I had bought gold years ago, I could sell it for so much more now!”
True, but all those years you would have kept gold in your portfolio, you would have been paying to keep it there. No matter how you hold your gold investment, it does cost something to keep it. If you keep your gold in exchange-traded funds (ticker symbol GLD), you pay a small fee to handle the price of “storing” the gold, and you pay your broker a fee on whatever you make on your gold. If you keep your gold in a safe-deposit box, you pay for the safe-deposit box and for the insurance you would need to protect your investment. The same goes for storing the gold in your home. The very thing that makes gold so attractive (the fact that it is tangible) is the thing that makes it so risky. If someone steals it, it is gone.
The ways mentioned above are the best ways to invest. It is not wise to invest in gold stocks – you are really investing in the company that mines the gold, so while you get partial ownership of that company’s gold, you are still vulnerable to that company’s business practices and financial pitfalls.
Even buying gold coins, bullion, or bars is potentially risky. You want to make sure you have the purest form of gold if you invest. Paying full price for a precious metal with fillers is a real possibility in a market that is flooded with questionable merchants pushing gold at every opportunity.
With so much to consider, one might be inclined to skip the current “gold rush.” Not so fast. For some investors, now is a great time to buy gold. If you have some extra money for investing and know how gold will affect your portfolio, gold is a great addition that will round out your portfolio and reduce fluctuations.As a long term investment strategy, adding gold to your portfolio is a wise decision.
Additionally, if you have a reputable dealer and some place safe to store it, you could buy gold to store yourself. There is something to be said for having assets you can touch.
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