Unleashing the Power of A Dividend Strategy: A Gateway to Earning Passive Income

Many Australian investors are on a quest to earn passive income. Apart from the dividends paid by ASX stocks such as major banks, for many the investment of choice is an Exchange Traded Fund (ETF).

According to an ASX study, building a “sustainable income stream” is the top priority across nearly every age group of:

  • Next generation investors
  • Wealth accumulators
  • Pre-retiree investors
  • Retiree investors

Why all generations love dividend income

Simply, the level of dividends paid by companies listed on the ASX is amongst the highest in the world.

This in large part reflects the effect of tax policies, particularly Australia’s system of dividend imputation.

But that’s not the whole story.

Many ASX companies have elected to pay out a higher proportion of profits as dividends rather than reinvest in their business to attract more investors.

Dividend-paying companies appear to generally smooth these payments and are reluctant to reduce their dividend payments in particular.

That’s not the case in the U.S. where investors primarily invest for capital gains. The average dividend payout ratio is 48% in the U.S. versus 67% for Australian listed companies. 

Many older generations of investors rely on dividends from ASX-traded stocks like the CBA, NAB, ANZ, and Westpac banks to fund their lifestyles. These stocks have regularly paid quarterly dividends in the range of 4-6% per annum, higher with the franking of dividends.

The result. Australia has amongst the highest levels of retail investors in the share market in the world.

Retail investors are non-professional market participants who generally invest smaller amounts than larger, institutional investors.

However, due to their smaller trades, retail investors may pay higher fees and commissions, although some online brokers offer no-fee trading.

ETF’s – growing asset of choice for younger investors

With this higher level of commissions, Exchange Traded Funds (ETFs) have become the asset of choice for many Australians and new investors with their lower cost structure.

According to the ASX study, more investors are starting with ETFs and overseas shares than previous generations.

Exchange Traded Funds (ETFs) can be powerful tools to achieve their financial goals, including generating passive income at lower costs than buying individual stocks.

What are ETFs?

Imagine a basket containing a variety of investments like stocks, bonds, or commodities.

ETFs are similar baskets that trade on stock exchanges like individual stocks. They offer instant diversification, meaning you own a slice of multiple companies or assets with a single purchase.

In an era marked by economic uncertainty and rapidly evolving financial landscapes, the pursuit of financial independence has become a common goal for many, especially among Gen Z and Millennials.

Retail investors are among the highest group of investors in ETFs in Australia. 

More Young People Want to Build An Income Stream

These include the oft-heard objectives of building a “passive income stream”, “side hustle” or a “sleeping stream”.

With traditional career paths being redefined and the gig economy on the rise, younger generations are seeking alternative avenues to secure their financial future.

Enter ETFs, an increasingly popular investment vehicle that offers a myriad of benefits, particularly for those looking to build passive income streams.

How can ETFs generate passive income?

Many ETFs traded on the ASX, particularly those that hold income-producing assets such as dividend-paying stocks, offer a steady stream of passive income.

Many ETFs distribute dividends, which are a portion of a company’s profits paid out to shareholders. When you hold an ETF that invests in dividend-paying companies, you receive a regular share of those dividends.

This creates a passive income stream that can grow over time, especially through reinvesting those dividends.

By reinvesting dividends or opting for dividend-paying ETFs, investors can harness the power of compounding, allowing their investments to grow exponentially over time.

Growing choice of dividend ETFs

Purpose-built dividend and income ETFs on the ASX have grown over the last decade.

This has simplified investing in a diversified basket of income-paying assets with a single trade, saving time and costs from having to analyse and manage a large number of individual securities.

Furthermore, many ETFs also offer distribution reinvestment plans (DRP), allowing investors to compound and grow their cash flows.

The advantage of dividend imputation

In essence, if Australian corporate taxes have already been paid on profits used to fund dividends, those taxes need not be paid again at the personal level by investors.

The corporate taxes paid are attributed, or imputed, to the Australian investor through tax credits called franking credits.

Franking credits can be used to reduce an investor’s total tax liability.

For investors who are individuals or complying superannuation entities, any excess franking credits can also be refunded at the end of the year if the investor’s franking credits are greater than their tax liability.

Access to franking credits

Equity-based ETFs traded on the ASX hold a basket of stocks that pay dividends, at varying levels of franking proportions, the franking credits flow through to investors to reduce their tax liability.

Investors should check the equity holdings of dividend ETFs to determine the level of franking credits.

Investors holding Australian share ETFs on and around the distribution dates could receive valuable franking credits and any cash distributions they receive.

Importantly, investors must hold a security for 45 days around a distribution or dividend date to be eligible for a franking credit.

Other perceived advantages of ETFs

Traditional non-listed managed funds often come with high expense ratios and management fees, eating into investors’ returns over time.

ETFs, on the other hand, are known for their low expense ratios due to their passive management style.

Many investors are choosing fintech platforms, robo-advisers, or Investment Platform Apps like Raiz that manage portfolios tailored to goals including income distribution, capital growth, and risk tolerance.

Diversification

One of the fundamental principles of investing is diversification, spreading investments across different assets to mitigate risk. ETFs provide instant diversification by holding a basket of securities within a single fund.

For young investors with limited capital, this allows them to access a broad range of assets without having to purchase each individually.

With expense ratios significantly lower than mutual funds, ETFs enable investors to keep more of their investment returns, enhancing the potential for long-term wealth accumulation.

Accessibility

Investing in ETFs is as easy as buying a stock. They can be purchased through any brokerage account, and fractional shares make them accessible even to investors with limited funds.

This accessibility empowers new investors to start investing with whatever amount they can afford, gradually building their investment portfolio over time.

Liquidity

ETFs trade on major stock exchanges throughout the trading day, providing investors with liquidity to buy or sell shares at prevailing market prices.

This liquidity ensures that investors can easily access their funds when needed, offering flexibility and peace of mind, especially in volatile market conditions.

Socially Responsible Investing

With growing awareness of environmental, social, and governance (ESG) factors, many ETFs now focus on socially responsible investing (SRI) strategies.

These funds allow investors to align their investment goals with their values, supporting companies that prioritize sustainability and social responsibility.

Conclusion

In conclusion, ETFs represent an investment alternative for new investors to build passive income/

They are also an entry point to the share market favoured by many investors.

With their inherent advantages such as diversification, low cost, accessibility, and liquidity, coupled with the potential for long-term growth and income generation, ETFs offer a compelling investment entry solution for new investors to the share market as well as those seeking low-cost diversification.

Compare ETFs in this handy section to find dividend income-paying ETFs, toggle Performance, and toggle Yield from highest to lowest.

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JustStocks Advisor

 

 

Disclaimer

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