Last Updated on 18/10/2024 by Carl-Peter Lehmann
At Henceforward, we take a holistic approach to financial planning and wealth management, crafting strategies that not only aim to grow your wealth but also enhance your income efficiently. One such strategy is leveraging shares and dividends to create a highly tax-efficient income stream, centered around dividend growth stocks. At the same time, this approach provides your portfolio with the opportunity to achieve long-term, inflation-beating returns. If you have a large share portfolio – valued at over R10 million – you may be underestimating its full potential, especially in how shares with high dividends can play a pivotal role in diversifying your income stream.
The Importance of Income Generation Using Dividend Growth Stocks
Many of our clients hold substantial share portfolios but often only see them as growth assets, or they expect their portfolio managers to simply “deliver the best returns”. Some portfolios have grown from company share options, or have been built up over time.
However, focusing purely on growth without considering other benefits, such as income generation and tax efficiency, can limit the portfolio’s true value.While buying and holding blue-chip shares has traditionally been seen as a sound strategy, it might not always serve your best interests. Share portfolios can generate a growing income stream, which can be tax-efficient due to the lower dividends tax. This income can supplement other sources, offering flexibility and reducing reliance on withdrawing funds from other investments. A well-structured portfolio, focused on both growth and income generation, can enhance your overall tax and estate planning.
Understanding a Family's Needs
The further up the wealth ladder you travel, the more complex you and your family’s needs often become. They are multi-dimensional, stretching far beyond simple wealth accumulation. Families often face a mix of goals and challenges, such as:
• Providing for future generations through education funds or estate planning.
• Generating reliable income to cover daily expenses or supplement retirement.
• Protecting wealth from inflation, market volatility, and unforeseen life events.
• Optimising tax efficiency, especially for high-net-worth families with complex financial structures.
• Aligning investments with personal values, such as socially responsible investing.
Families need a flexible strategy that adapts as circumstances change, from growing wealth to preserving and distributing it.
The Role of a Financial Planner and Wealth Manager
At Henceforward our role is like the architect of the family’s financial future, taking a holistic view of assets, liabilities, cash flow, and long-term goals. Key responsibilities include:
1. Goal setting: Understanding the family’s long-term objectives, from retirement to passing on wealth.
2. Cash flow management: Ensuring income streams are stable and sufficient to meet lifestyle needs.
3. Tax and estate planning: Structuring income and investments to minimise taxes and maximise the transfer of wealth.
4. Risk management: Identifying risks and suggesting solutions, such as insurance or emergency funds.
5. Investment oversight: Ensuring the family’s investment strategy aligns with broader financial goals and risk tolerance.
6. Succession Planning and Family Investment Charter: Facilitating discussions about succession and creating a Family Investment Charter, which formalises the family’s financial principles and legacy. This ensures a smooth transfer of wealth across generations and helps define the family’s shared values and financial goals.
In essence, we provide the roadmap for the family’s financial journey, ensuring that every part of the balance sheet is working towards the family’s goals, including preparing for future generations.
The Role of a Portfolio Manager In Using Shares and Dividends to Craft Your Income-Generating Share Portfolio
A portfolio manager, on the other hand, focuses specifically on investment management. Their role includes:
• Security selection: Choosing the right shares, bonds, or other assets based on market conditions.
• Asset allocation: Ensuring the portfolio is diversified and balanced to minimise risk while maximising returns.
• Performance management: Regularly reviewing and adjusting the portfolio to optimise returns.
Simply put, the portfolio manager is the engine that drives the family’s investment growth and performance.
Why Financial Planners and Portfolio Managers Should Work Together
For families with significant wealth or complex financial needs, it’s crucial that financial planners and portfolio managers work together as a team.
• Goal alignment: The financial planner sets the broader financial strategy, while the portfolio manager executes it within that framework, ensuring that investments meet the family’s goals.
• Consistency: Financial planners understand the family’s overall financial picture, while portfolio managers bring market expertise and asset management skills. Together, they ensure that the strategy is consistent across all areas.
• Flexibility and adaptability: As a family’s situation changes (e.g., selling a business, retiring, or facing a market downturn), the financial planner and portfolio manager should pivot together, making adjustments to both the overall financial plan and specific investments.
Case Study: Creating Bespoke Solutions for an Income Generating Dividend Share Portfolio
At Henceforward, we understand that families with significant wealth have the ability to leverage their assets for bespoke financial solutions, rather than settling for generic, mass-market approaches. Tailoring a strategy to your unique circumstances allows you to optimise your wealth and reduce risks specific to your industry.
For example, if your family business is in the retail sector, it might be wise to hold fewer retail stocks in your family trust to ensure better diversification. This approach protects your portfolio from being overexposed to a single sector. Similarly, if your wealth is tied to the agriculture sector, your portfolio could be constructed to counter the Agri cycle, providing uncorrelated returns when the industry is under pressure. These customised strategies deliver the stability and security your family needs in a changing economic environment.
Different Types of Shares: Compounders vs. Sprinters
Once the financial planner and portfolio manager are aligned, the next step is structuring your portfolio to meet your specific objectives. This often involves a mix of different types of shares that offer either consistent, growing income or capital growth with more volatility. This is where we differentiate between Compounders and Sprinters.
Compounders vs Sprinters
There are two main types of shares that can play an important role in your portfolio:
1. Compounders: Shares that provide a consistent, growing income. These are often dividend-paying shares from sectors like banking. For example, FirstRand (FSR) has shown:
– 11% per annum share price growth over the past 20 years.
– 12.6% per annum dividend growth over the same period.
These shares provide stability and a growing income stream that supports both growth and income needs. Banking Shares are what we typically refer to as compounders. Their main source of income/earnings is “Net interest income”, an annuity income stream. The management of bad debts is also an important part of what a bank does, but good management teams and robust capital adequacy positions de-risk these businesses significantly. That is what allows banks to be consistent dividend payers, outside of global macro black swan events and financial market dislocations.
Breaking it down, businesses with stable annuity earnings can form the cornerstone of portfolio providing the income-generating stability, according to Andre Vos, a Portfolio Manager at Sanlam Private Wealth
2. Sprinters: Cyclical shares, such as those in the mining sector, can provide strong capital growth and larger, but often erratic, income streams. For example, BHP Billiton:
– Paid R4.50/share in dividends in 2016.
– Grew dividends to over R52/share by 2022 due to favourable market conditions.
However, these shares can fluctuate more drastically, as seen in 2023 and 2024, where dividends decreased. The R27/share received this year (2024) represents a yield of 5% on the current share price of R530, which is still a decent yield.
Both compounders and sprinters have their place in a portfolio, but it’s important to allocate based on your investment goals and current market cycles.
A “buy and hold” strategy may not always be the best approach, especially for cyclical counters. For instance, BHP made up 10% of a portfolio three years ago but now represents less than 3%, highlighting the importance of adjusting allocations over time, according to Vos.
Tweaking Shares and Dividends for Cyclical Tailwinds (Active Strategy)
• Cyclical Sectors: Over the years, certain sectors such as resources (mining) have shown cyclical behaviour. For instance, during periods of high commodity prices (such as the China-driven commodity super cycle), resource companies significantly outperformed. Financial and industrial sectors often rallied during times of economic expansion.
• Potential Alpha: Active investors who adjusted their portfolios to overweight resources during commodity booms, such as between 2001 and 2008, or underweighting them during down cycles (like the 2015-2016 commodity slump), could have achieved higher than average returns. Tailwinds in specific sectors can provide returns as high as 20-30% per annum during peak cycles.
• Timing Risk: However, timing these cycles requires significant skill. If incorrectly timed, this strategy could have resulted in underperformance, especially if certain sectors, like resources, underperformed for extended periods, such as the post-2008 global financial crisis era.
Further Reading: 15 Essential Investment Principles to Follow That Will Give Your Long-Term Investment Success
Example: Commodities Supercycle (2000-2008)
• During the commodities supercycle (driven largely by China’s rapid industrialisation), the resources sector on the JSE dramatically outperformed the Top 40 index. Resource-heavy stocks like BHP Billiton and Anglo American saw massive price increases.
• Investors who “tweaked” their portfolios to capture this tailwind could have realized annualized returns upwards of 25-30%, compared to the average Top 40 return of around 15% in the same period.
Example: Financial Crisis and Recovery (2008-2013)
• After the 2008 financial crisis, financial and industrial stocks recovered quicker than resource stocks. Those who adjusted their portfolios away from resources toward financials and industrials could have captured tailwinds in these recovering sectors, outperforming the broader Top 40 index.
Read Next: Understanding The Various Forms of Investment Risk Will Help You Become a Better Investor
Conclusion: The Importance of Quality Research
Effective portfolio construction starts with understanding your financial goals. As Andre Vos from Sanlam Private Wealth, advises, “Owning enough of the quality stuff, with a few tweaks around the edges, ensures that a family’s goals are met.” For growing Trust portfolios, income is often a key priority, and choosing shares that provide a growing and tax-efficient income stream is vital.
If your share portfolio exceeds R10 million, and you want to ensure it’s being managed efficiently, in line with your financial goals, and with tax efficiency in mind, we’re here to help. Our holistic approach ensures that your wealth is protected and growing in a way that meets your family’s needs. Get in touch with us today to see how we can add value to your portfolio and secure your financial future.
Now Read: 17 Blue Chip Global Dividend Growth Investing Ideas for Offshore Share Portfolios
Steven Hall
Steven is the Founding Partner and a Director at Henceforward. He is a CERTIFIED FINANCIAL PLANNER with over 20 years experience helping clients and families manage their wealth and income needs.
