Dear Reader,
Have you ever spotted a new share to buy, but then been disappointed to learn that it doesn’t pay the level of dividend you wanted?
Well, in today’s issue I’m going to show you how to dictate your own dividend policy. I’ll show you how to get exactly the level of dividend that you want from all the shares that you own. Plus you get to wipe the smile off the tax man’s face. Let me explain…
You won’t be alone if you have hang-ups about the distinction between income and capital. It may have been drummed into you that capital is for guarding carefully and never for spending, and that “dipping into capital” to generate an income puts you on a slippery slope.
But to succeed at investment, you must learn to separate pre-programmed modes of behaviour from investment facts and realities. I will show you how a noble intention to protect capital could even achieve the very opposite of what you intended.
For your wealth’s sake, think “total return”
First a harsh truth…all investment cash – be it “income” or “capital” – spends the same. Once turned back into cash, income and capital become indistinguishable. The two are subject to different rates of tax, which I will come onto in a minute. But that’s where the difference ends.
You may pursue an investment strategy that emphasises income over growth, or vice versa. Indeed many of us have no choice but to take the best income we can from our investments. But – at the finishing line – the size of your nest egg will be determined by its total return (that’s growth and saved income, net of tax) over the period of your investment.
If you hold investments that pay out an unrealistically high income, you could be putting your future wealth in danger. Should they suddenly reduce or stop paying an income, their capital value could drop sharply. And you can’t re-invest the capital elsewhere after it has disappeared...
But there is a solution. It’s a strategy that lets you take an income if need be, but without falling into the “high yield trap.” It all comes down to understanding the tax position – both your own and that of the company in which you re investing.
Dividends – unless collected in a pension or ISA – are taxable at 10% for a standard rate taxpayer and at 32.5% for high rate taxpayer. But, as I’ll explain in a moment, the relatively low 18% rate of tax on capital gains can provide a stunning opportunity to generate income efficiently. And if companies would try this too, we could all be better off!
Don’t let dividends deplete your shareholdings
When a company makes a profit, this belongs to the shareholders irrespective of whether it is paid out as a dividend or not. If it stays in the company, it is carried forward as part of the company’s capital and reserves. It can be used to finance future growth by, for example, being spent on new factories or research and development. Retaining profits in this way can therefore help to assure future growth in profits.
If the profit is paid out as a dividend, part of this potential new capital is immediately lost to taxation. In the company’s hands that’s 10% withholding tax, which is a down-payment on its corporation tax bill. Dividends are quoted and paid net of this, and the recipients are deemed to have had 10% tax deducted at source. So a minimum of 10% is lost in tax when profits are distributed by a company. And this leaching of capital, compounded over the years, can have a big negative effect on your investment returns.
So never buy a share just for its dividends. The high dividend may simply be jeopardising the company’s future growth.
Here’s how to dictate your own income policy
If that puts low-paying or zero-dividend companies out of bounds for income investors, it shouldn’t. Remember that it is total return – income and capital, not one rather than the other – that counts. Investors are always free to manufacture their own dividends by selling a share or two. So hold reliable growth shares rather than moribund high yielders and then be ready to sell a few for income.
From a tax perspective, it can make a lot of sense to generate “income” in this way. A share sale takes you and the company out of the net of income tax and corporation tax altogether. And – unlike a dividend – a share sale does not take capital out of the company, reducing its ability to grow profits in the future.
In shareholders’ hands such a sale is a capital receipt, free of income tax, and can make good use of the annual exempt amount for capital gains tax (CGT), currently £10,100. Think of it as an additional raft of personal tax allowance. And even when you have used that up, additional gains are taxed at just 18%, compared with up to 32.5% if the cash came from “proper” dividends. Everybody wins.
It is better still when you realise that – even if you have exhausted your £10,100 allowance – CGT applies not to the proceeds of the sale, but to profits on the sale. A share would have to be showing a profit of over 100% before the CGT charge reached 10% of the proceeds, equating it with the income tax on dividends.
The message is clear: manufacturing rather than collecting dividends can have tax advantages both for shareholders and companies. It also allows the compounding effect over time to be maximised.
So don’t avoid a company just because it does not pay a generous dividend. If it grows your capital, you can always sell a few shares to “make” the dividend of your choice. In fact you could even reduce or eliminate your tax bill by manufacturing “DIY dividends.”
And think very carefully before buying a share for its yield. You may be seriously jeopardising your long-term wealth. That’s why you must stop thinking of income and capital as completely different. Remember, it is total return that counts.
Good investing.
Andrew Vaughan
For The Right Side
Publisher’s Recommendation: Andrew Vaughan is the investment director of a discreet circle of investors called The Zurich Club. He’s just uncovered a clever way you could earn extra 37% on shares you already own. It doesn’t matter what shares you own or how long you’ve had them. It’s a little-known, low-risk strategy used by professional investors and could very simply earn you a series of satisfying gains starting as soon as next month. Interested? Click here and read the brand new report Andrew’s prepared, it tells you everything you need to know about this hidden strategy.
Note: Forecasts are not a reliable indicator of future results. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Please seek independent financial advice if necessary.
MARKET NOTES
Charting the fall of the dollar
BY SHIVVY ARORA
The greenback continues to take a beating. Since its peak in March this year, the dollar has dropped more than 10% of its value relative to other major currencies.
Take a look at the chart below. It shows the US dollar index (black line) for the year-to-date. This measures the value of the dollar against six other major currencies. You can see how it’s plunged since March (circled).
At 79.8, it is also trending far below both its 50-day (blue line) and 200-day (red line) moving averages, i.e its average prices over 50 days and 40 weeks respectively. These are both important lines of resistance for the index.
The dollar is on a major downtrend...
Source: Stockcharts.com
The dollar is falling as America loses its appeal as a place to invest. Already, foreign investors are fearful of putting money into US bonds. And American investors are moving into non-dollar assets and precious metals. It’s even possible that the currency will also become unattractive for reserves held by the world’s central banks.
In the meantime, the Federal Reserve continues to print, print, print new dollars. This is pushing America’s budget into an even larger deficit. This massive "money pumping" is a crucial reason for the weakening of the currency.
If the dollar continues sinking, we’ll see foreign appetite for US assets plunge even further. Ultimately the currency’s ‘safe haven’ status will lose its shine.
There’s little or no safety in the greenback anymore. We see no respite for the dollar in its swift downward spiral.
The Daily Reckoning – Grand larceny on a Super-Madoff scale
BY BILL BONNER
London, England
Wednesday, 24 June 2009
“Politics is about what works,” said Hillary Clinton. At least, we think it was Hillary Clinton. Someone said it. Someone who is an imbecile.
Politics is not about what works, it’s about what you can get away with. And what you can get away with is often exactly what doesn’t work at all.
Our beat is money, here at the Daily Reckoning. We specialize in fraud and folderol. We leave the homicide beat to someone else.
What the US is getting away with, from a financial point of view, in addition to counterfeiting, is very grand larceny on a Super-Madoff scale. It is borrowing trillions of dollars even though it has no way to honestly pay back the money.
Still, so eager are the lenders to part with their money that the yield on the 10-year T-note fell yesterday to 3.64%. The more the feds borrow, apparently, the more lenders are willing to lend.
We’re in the Third and Fatal stage of a great country – the political stage. In this stage, money and power migrate from the financial community to the political community. The politicians get away with taking trillions out of the productive economy and spending them on their pet projects and private corruptions.
Warren Buffett described the America of the Bubble years as “Squanderville.” Private citizens were living beyond their means, he pointed out. But he hadn’t seen nothin’. Now, the squandering is done by government. The politicians are spending trillions they don’t have on projects nobody was willing to pay for even when they had some money in their pockets.
What the government can get away with now – under cover of a financial crisis – is a big grab for money and power. It ‘works’ in the sense the feds are able to get away with it. But it will prove fatal to the dollar... and to the US economy.
We will return to that subject below...
Back in the markets, the Dow fell modestly yesterday, down 16 points. Oil clung to the $69 level. Gold was up $3 to $924. And the dollar saw its biggest drop in weeks as speculators waited for word from the Fed on its next move.
The Fed is expected to talk about an “exit strategy.” It is intervening in markets as no Fed ever has. Its balance sheet – a measure of how much intervention it has done – has shot up in a way that is not only unprecedented, but almost unbelievable. In an effort to provide liquidity, it has bought up the contents of every neglected refrigerator on Wall Street. The smelly, furry stuff – “toxic” derivatives... SIVs... MBAs... no one seems to know exactly what it is – enters the Fed’s books as an asset. Altogether, along with its not-so-pungent holdings of US Treasury bonds, the Fed’s balance sheet shows more than $2.7 trillion worth of assets.
What happens next?
Read on…
To read the Daily Reckoning in full, click here.
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