As the ‘euromess’ meanders along and interest rates in Australia fall and are set to fall further, a top of mind question for many DIY super trustees is: how do I select an income-biased portfolio of stocks to help ride out the storm? An effective after tax yield of 7% per annum provides quite a bit of downside protection – particularly over a medium-term horizon.
It is no surprise that the secret to an income-biased portfolio lies in a balanced portfolio of stocks paying franked dividend yields. To recap on the effectiveness of franked dividends in super, a fully franked dividend yield of 6% pa is worth 7.29% in the accumulation phase and 8.57% in the pension phase of your SMSF.
After tax yield in accumulation After tax yield in pension
So, to the portfolio. I will use a ‘top down’ approach, which starts by looking at a sector allocation and then moving on to the individual stocks. The latest ASX data shows that the stocks that comprise the S&P/ASX 200 are trading at an historic price to earnings ratio (PE) of 12.7, with a weighted average dividend yield of 4.68%. Within the individual sectors, the picture looks as follows:
Now to the stocks. I’m after around 15 to 20 (less than 10 is too small, more than 25 is too hard to keep track of). There are industries that, at least in an Australian context, are chronic underperformers, so I’m not interested in stocks from the airline, insurance, building materials or steel industries. I’m going to confine my portfolio to the ASX 100 (that doesn’t mean that there aren’t some fantastic smaller companies), and of course, I am looking for companies that pay franked dividends.
In the Financials, I’m sticking with the majors, avoiding insurances and the minor banks (however, Bendigo is worth considering). I’m not keen on Consumer Discretionary and staying underweight, and despite the selloff in JB Hi-Fi on Friday, marginally lean to David Jones.
Ramsay’s high PE doesn’t put me off, and in both Materials and Energy, it’s hard to go past the industry leaders. The same goes for Telecommunications with Telstra.
While the relative individual stock weightings are largely aligned to their index weighting, I also apply a qualitative overlay about the company’s management and the track record in delivering consistent earnings. There are often good reasons why some stocks always trade on a higher PE than their peers (eg. Commonwealth Bank vs National Australia Bank).
The high-income portfolio
My high income portfolio (per $100,000 invested) is as follows: