The Joy Of Dividends

We love dividend payments, whether they be in the form of a cheque in the post, a direct debit into you bank account, or are reinvested via a dividend reinvestment plan. To long-term investors, dividends in high quality companies are the gifts that just keep on giving.

On the flip side, resident individual taxpayers are liable to pay tax on their dividend receipts. Trust the taxman to spoil the party!

But there is some good news. Unlike most other countries, dividends from Australian listed companies are often paid with franking credits attached. Called dividend imputation, prior to their 1987 introduction a company would pay company tax on its profits and if it then paid a dividend, that dividend was taxed again as income for the shareholder, a form of double taxation.

As far as the taxman is concerned, you are entitled to a franking tax offset equal to the amounts included in your income. In essence, the franking tax offset will cover, or partly cover, the tax payable on the dividends. If the tax offset is more than the tax payable on the dividends, the excess tax offset will be applied to cover, or partly cover, any tax payable on other taxable income you received.

Here’s an example of franking credits in action.

Cash Dividend Received (Franked amount)                        $700

Franking Credit (at the tax rate of 30%)                              $300

Gross Dividend                                                                    $1,000

For a 45% taxpayer…

Tax payable (45% * $1,000)                                                   $450

Less Franking Credit Offset                                                    $300

Net tax payable                                                                       $150

Net after-tax dividend received ($700 – $150)                       $550

So, instead of paying tax of $450, as you would in many other countries, Australians only pay tax of $150. Happy days.

The other thing to note is, when you take franking credits into consideration, the dividend yield on your investments is effectively higher. You might see the terms “gross yield” or “grossed-up yield” when quoting the dividend yield on a share.

Using the example above, if you owned $15,000 worth of shares in the company…

Cash dividend yield ($700/$$15,000)                                    4.67%

Gross yield ($1000/$15,000)                                                  6.67%

Net after-tax yield ($550/$15,000)                                          3.67%

By way of comparison, if you’d received $700 interest from a $15,000 investment in a term deposit or savings account, the after-tax return would only be 2.57%.

Bitcoin and Gold, Bosom Buddies?

Bitcoin used to have a mind of its own. Prior to the last three months, the digital currency traded with the ebbs and flows of merchant acceptance. The following chart illustrates my point, it is the 30 day change in the price of bitcoin plotted against the 30 day change in the amount of bitcoin transactions.

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There is a clear negative correlation between price movements in bitcoin and the amount the digital currency is being used for transactions.  My simple explanation for this inverse relationship is that as new merchants begin accepting bitcoin they immediately sell it for fiat currency.  This has meant that contrary to popular opinion, in the short run merchant acceptance is not good for the price of bitcoin. Of course, in the long run merchant acceptance is essential to the growing bitcoin ecosystem.

However, something different has been occurring over the last three months – bitcoin has begun trading in lockstep with gold. The following chart shows the prices changes in bitcoin and the gold ETF over the preceding 90 days.

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I will be the first to scoff that correlations are made to be broken, but the relationship does have some basis in economics. One characteristic of bitcoin is its limited supply (only 21 million coins will ever exist). As well, like gold it is a currency and I would argue it is a better currency than gold.  Unlike gold, bitcoin can be used to purchase goods and services, just try buying something on Overstock with gold…you wont get too far.

So is bitcoin doomed to be the digital cousin of gold? Hardly. In fact I find it encouraging that it has begun to take on the trading characteristics of more mature financial markets.  As bitcoin matures more speculators will be attracted to the market and the simple act of converting some gold holdings into bitcoin could have a dramatic effect on price.

The Bitcoin Investment Trust has a handy little table that indicates what could happen to the price of bitcoin if only a small portion of the investment dollars in gold migrated to the digital currency.

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If bitcoin equaled only 5% of the value of gold, the implied price would be $47,010…quite a jump from the  current $335!  To be sure, taking on the characteristics of gold is not a one way ticket to the moon.  If bitcoin is disrupting gold as the ultimate store of value, it will also be subject to the downside.

The promise of Bitcoin the technology is the disintermediation of financial services…perhaps the digital currency is fulfilling its destiny and has chosen to start with gold.