Investing on the ASX for fully franked share dividends has been a great way to invest for donkey’s years.
Since the GFC of 2008/2009, investors focused on income won both ways:
- They avoided falling interest rates on term deposits and savings accounts
- They benefitted from one of the longest bull markets in history
But with markets hitting a rocky patch, more of us are now questioning, has the music finally stopped playing?
This question is especially pointed for dividend investors knee-deep in Telstra Corporation (ASX: TLS), BHP Group (ASX: BHP), utility companies and the banks.
High-Interest Rates, Ahoy!
For years, economists couldn’t make their mind up about which way interest rates were going. There was more umming and ahhing than a MoMA exhibition.
But over in the USA, interest rates are already on the way up and are likely to go higher yet. And the return to normalised interest rates — sooner rather than later — means a few things for investors:
- Volatility is coming back (the VIX or ‘fear’ index is trending upwards)
- Stretched balance sheets will be tested
Here in Australia, the banks have already hiked mortgage rates ‘out of cycle’.
How to Avoid Getting Hit By High Rates
I have a terrible track record when it comes to trading macroeconomic trends. Fortunately, that’s not how I invest – not in the slightest. I’m a ‘bottom up’ investor who focuses on the fundamentals of business.
One of the fundamentals I focus on is debt. I made a decision early on in my career that I should just avoid companies with high amounts of debt.
Companies with strong balance sheets are the captains of their own ship whereas companies with lots of debt can be subject to the demands of their creditors. What’s more, debt can paralyse companies and operating leverage (e.g. for software companies) can be just as powerful as financial leverage (using debt).
And let’s not forget, we have 2,000+ shares on the ASX to choose from, plus thousands more globally. In addition, we have nearly 200 ASX exchange traded funds (ETFs) and many hundreds more overseas.
So here’s my two-step strategy for sleeping easy at night:
- Remember “it’s different this time” are the four most dangerous words in investing, and assume interest rates will one day return to a more normal level (adjust valuations accordingly)
- Avoid companies in a net debt position wherever possible (i.e. avoiding companies with more debt than cash)
I’m not saying all debt is bad, far from it…
For example, I own one tiny Australian company which has more debt than cash. The entire company, which is held in the Rask Invest model portfolio, is worth less than $50 million.
If I’m right about the company, I think its use of debt could multiply the value of its shares many times over — that’s the good side of financial leverage.
However, I have to say the company is the exception and not the rule. It’s the only company I own which is in a net debt position. How many of your shares have net debt?
Is It Worth Investing With Rising Interest Rates?
Yes, I think long-term investors shouldn’t be scared away by rising interest rates.
As I have noted in recent weeks, many of the ASX’s biggest blue chips are offering dividend yields over 5% thanks to the recent selloff.
Further, there are techniques you can use to mitigate the effect of interest rate rises. For example, you could diversify using ETFs, or find companies with fixed-rate debt and long-term contracts. The tiny company I mentioned above typically contracts its customers for 5+ years!
Outside of your investment portfolio, I think it’s also worth looking at paying down debt and freeing up capital to maintain flexibility. Paying down debt with interest rates over 10% feels good, makes financial sense and gives you firepower when share prices fall.
Once your financial house is in order, I think it’s smart to consider putting most of your wealth in the best long-term compounding machine we have available – the sharemarket.
Rain, hail or shine, that’s what I’m doing.
Founder, The Rask Group
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Disclaimer: Any information contained in this article is limited to general financial/investment advice only. The information has not taken into account your specific needs, goals or objectives, so please consider consulting a licenced and trusted adviser before acting on the information. Please read The Rask Group’s Financial Services Guide (FSG) for more information. This article is authorised by Owen Raszkiewicz of The Rask Group, which is a corporate authorised representative No. 1264179 of Strawman Pty Ltd (ACN: 610 908 211) (AFSL: 501 223).