Increase income by 'recycling capital'

Ever noticed a share price run up as an entitlement to a dividend approaches?
Investors buying in anticipation of a strong dividend can see the share price can run up and once announced, it can go even further as others buy in. Buying shares to gain dividends and franking credits can be profitable. However, it may require trading capital to be 'invested' for some months. Choosing an instalment over the same share can provide benefits over buying the share itself.

Instalments function like Telstra Instalment Receipts (IRs) with two payments - one up front and another due on a pre-determined future date (expiry). As with Telstra IRs, the holder is entitled to all dividends and franking credits after the first payment which enhances yield. Unlike Telstra IRs, the second instalment payment is a non-recourse loan upon which the holder has paid interest and a protection cost. Because of the non-recourse nature of the second payment, instalments can be used within self managed super funds (SMSFs), even though there is an element of gearing as there is no call on the borrower to repay the loan and no margin calls. Instalments are traded on ASX and can be bought and sold the same way as shares. To find out more about the features, benefits and risks of instalments visit the ASX warrants website. 

The dividend yield play (DYP)

Known as the dividend yield play, it's a short-term trading strategy that allows investors to receive dividends and franking credits by holding successive instalments over a range of shares for short time periods. This effectively 'recycles' the same capital - buying, taking dividends, selling and moving to a new investment. This has the potential to increase income received, providing multiple dividends from the same capital and to increase the yield on each 'investment', as only a proportion of the share price is invested using the instalment over the share for the same dividend received.

But there are guidelines

As with any strategy there are rules or guidelines. The most notable is to plan ahead.  An investor choosing this strategy will have a good idea of the likely dividend well in advance of its announcement. Investors should also undertake research including checking past dividend payments and being aware of any changes (positive or negative) that can affect the dividend payment as well as the general environment in which the company paying the dividend operates (economic and industry sector).

The ASX website has past dividend payments. Simply enter the codes of the stocks that you're interested in to view the details.

Future estimates of dividends based on the views of options market makers are also available on the ASX website. Please note that the dividends indicated here are not a guaranteed outcome and are a consensus view and subject to change. 

The other important guideline is to understand the instalment type you choose, it's gearing and time to expiry. Choosing a 'vanilla' instalment as opposed to a 'self funding' (SFI) instalment would have the effect of ensuring the dividend is paid as cash rather than being used to reduce the second instalment payment amount. With this strategy, you want the cash dividend. Ensuring that there is sufficient time after the 'ex' date to the expiry of the instalment will buy you time to allow for the price to recover after the dividend is paid. A highly geared instalment, while requiring less capital, has a higher interest cost as the amount borrowed is a greater proportion of the underlying share price.

Importantly, you will need to hold the instalment over the ex dividend date. However, you can sell the anytime after that date and still receive the dividend.

Rules

To gain the benefit of the franking credit an investor must hold the investment for 45 days excluding the day of purchase and sale, which is 47 days in total. This is known as the '45 day rule' and applies to an investor who is entitled to receive greater than $5,000 in franking in a financial year from all sources - instalments over shares or shares themselves. If the total of franking credits received from all investments in the investor's name in the financial year is less than $5,000, then the rule does not apply.

More about instalments