Death of Dividend: Here's How to Recharge Your Passive Income Strategy
Relying on dividends for a passive income might not be the smartest idea anymore. Here are some alternative strategies to consider.
The economic devastation caused by Covid-19 has been unprecedented, with most countries across the world only just starting to recover from the unforetold effects of the virus. One of the more prominent financial casualties of the pandemic has been the domain of "dividend-based income schemes," often relied on by entrepreneurs as they seek to achieve the best of two worlds — capital appreciation of an equity investment with a regular cash flow customary for a fixed income instrument. This is a particularly convenient strategy for those heavily invested in their businesses while needing a regular income stream to fund their day-to-day expenses.
After a dire year for corporate payouts, where an increasing number of multinationals will have to cut or cancel their dividends altogether, a whopping 75 percent of all UK-based firms have already had to resort to such measures. To put things into perspective, this figure was only 40 percent during the last major dividend crises — i.e. the 2008 credit recession.
But dividends have been on the decline for decades, falling from grace since the 1990s when the average payout ratio for S&P 500 companies fell to 30 percent from a previous fluctuating average of 40 percent to 60 percent between 1950 and 1990. Additionally, as per data recently made available by global financial administrators Link Asset Services, one can see that during Q2 2020 alone, the total amount paid in dividends by UK companies fell by 57.2 percent to £16.1bn, signalling a cut of almost £22bn.
Covid-19 has merely accelerated the inevitable: Cuts were coming anyway.
What's causing this to happen? What lies ahead?
While there are many nuances to why dividends are going out of fashion, one of the main reasons at the moment is the need for companies to hoard cash due to today's uncertain economic climate. Secondly, dividend receipts are incredibly inefficient and cumbersome when it is time for a person to file their taxes. Lastly, an over-reliance on dividend income tends to signify an absence of alternative attractive investment opportunities in the market.
The lockdowns have also spurred on the aforementioned slew of dividend cutbacks, which are likely to continue well into the future as companies start to pay off vast debts they may have gathered during the crisis. As a result, it is anyone's guess as to how much more debt most companies will have to accrue, especially as lockdown restrictions continue to be implemented across the globe.
Alternative investment strategies worth considering.
For entrepreneurs who rely heavily on dividend-based monetary streams, it may seem as though the ongoing pandemic has turned their world upside down. Since there is so much economic uncertainty across most markets today, individuals should maintain diversity across their portfolios, spreading their investments across a variety of different regions, sectors, and asset classes. For example, dividends emanating from companies affiliated with the defence, healthcare, and technology sectors have faced little to no pressure throughout the coronavirus crisis. They may, therefore, be potentially lucrative investment avenues.
Similarly, forward-looking entrepreneurs may choose to switch up and modernise their strategies by considering inflation-beating assets such as cryptocurrencies or even precious metals like gold. While neither Bitcoin nor gold pays any dividends, it's always possible to sell some of your holdings during bull cycles in order to lock in profits, thus allowing owners to generate steady cash streams as and when required.
People might even want to consider different asset classes such as high yield and emerging market bonds that can routinely deliver gains ranging between 3 percent to 4 percent, which, in this low-interest-rate environment, could be quite an attractive option for many. Other options include "investment trusts' since they can borrow from or use their "revenue reserves' - which basically comprise of the dividends they receive any given year — allowing their backers to draw steady income streams even during leaner periods.
Lastly, micro-investing is another untapped domain that is fast gaining prominence. It affords entrepreneurs the ability to maximise their money's growth potential while giving them a good shot at beating many common inflation-related woes. In fact, over the course of the last few years, a number of digital platforms such as OSOM Finance, Acorns, and Robinhood, have made the process of micro-investing extremely streamlined and hassle-free for those interested in exploring this space.
The new normal and the adverse effects of low-interest rates.
With interest rates being cut by central banks globally, it has become easier for people to borrow money than ever before. For example, in the wake of the coronavirus pandemic, many Central Banks cut interest rates to essentially zero in 2020, primarily as a means to shelter their economies from the effects of the virus.
Whileon paper this may sound good because reduced interest rates can increase consumer/business expenditure, enhanced market investments, etc., it can also result in inflation and the creation of a liquidity trap which can severely devalue one's local fiat currency.
For example, following the 2008 credit crisis, the Fed lowered rates and injected money into the economy to increase economic activity. However, the move created a liquidity trap — wherein people started to hoard cash in fear of another market crash — and as a result, the American economy failed to expand despite zero/very low-interest rates.
Low-interest rates can reduce one's spending power and have an adverse impact on a country's middle class because when interest rates are lowered, unemployment rates can increase since companies can lay off well-paid individuals in favour of contractors, temporary/part-time workers at much lower rates.
This, in turn, facilitates a wage decline across the board, creating a highly undesirable social environment wherein individuals have to reduce their standard of living since they can no longer afford to pay for even essential goods and services.
One final hurdle that entrepreneurs can face whether they are looking to make income off of dividends or not: Capital. The alternatives outlined above, whether cryptocurrencies, high-yield bonds or even micro-investing, are all far less lucrative if an individual doesn't have a notable portion of money to stake in the first place. This essentially creates a barrier to lower class citizens who may have little or no spare cash and are living paycheck to paycheck. While new services and technologies are certainly lowering the barrier for entry, realistically valuable returns are near impossible without sizable upfront investments, particularly for the instruments with a fixed income component.