Before you get the pitchforks, hear me out.
I know ASX investors love their big dividends and the franking credits that often come attached. It's a quirk of our tax system that most other countries don't offer and we Aussies are fiercely protective of it (just ask Bill Shorten).
But at the same time, our love of a fully-franked yield may be putting those that rely on dividend income to live (in retirement or otherwise) at risk – here's why.
The Australian share market is one of the highest yielding share markets in the world. All dividends are actually taxed twice – once when the company banks a profit (corporate tax) and once when the dividend is received (income tax). In countries like the US, this is allowed to stand, and so investors actually don't really like getting dividends as much as we do – its double-taxed income. But in Australia, we get a refund for the company tax, also known as a franking credit that we can use to offset other income (or get a refund).
This, in turn, encourages companies to pay out as much of their earnings as possible – why do you think ASX bank shares are so popular? As soon as a company starts making a profit, investors will usually start demanding a dividend.
But here's the problem. If a major priority of an ASX company is a high payout ratio, it leaves the company vulnerable to an economic downturn or a recession.
Over in the US, there is a list of companies who have maintained or increased their dividend for 25 years or more (known as dividend aristocrats). Currently, there are nearly 60 companies on that list.
You want to know how many ASX dividend aristocrats there are? Zero.
In fact, you can count the number of ASX companies that have managed an annual dividend increase since the year 2000 on one hand.
The Foolish Takeaway
Put simply, our love of dividends (and franking credits) forces companies to pay out profits at such a high rate that they cannot be sustained in a downturn. And this is when retirees and other income investors need a regular income the most (ask any retiree who battled through the GFC).
There isn't an easy solution to this problem, but (in my opinion) balancing risk by choosing the highest-quality companies and diversifying your investments is always a good bet.
