Have you ever considered relying on dividends to meet your income requirements? While not usually a first port of call for the average income-seeking investor, a strategy that is premised on investing in companies that offer relatively generous dividends can well meet the needs of these investors, while also offering exposure to the capital growth of the share.

Dividends have never been a traditional source of income because of the inherent volatility of equities. But we can learn from the world?s wealthiest people, many of whom live solely off their dividends.

So what do you need to look out for if you are considering a dividend-based investment strategy?

Understanding yield

Yield is the annual rate of return on an investment, measured as a percentage. When it comes to equity funds, the yield measures the dividend income paid out to investors as an annual percentage. The dividend yield is calculated as the annual dividend income per share divided by the share price.

In contrast, the yield on a money market fund measures the interest paid out to investors. Money market yields are based on rolling seven-day periods and then annualised to give a one-year figure. This rate should be comparable with most quoted interest rates.

Dividends versus interest income

Dividends are the portion of a company?s earnings paid out to investors. While most companies tend to keep their dividend yields relatively stable, they may well consider scrapping or reducing their dividend during difficult business conditions, such as now, preferring to reinvest the funds in the business instead.

For now, dividends are taxed in the hands of the company and not the shareholder, but new dividend taxation legislation is currently being finalised, which, once implemented, will impose a dividend tax of 10 percent on individual shareholders.

Fixed-interest yields, on the other hand, are directly related to prevailing market interest rates, so as rates come down, so will the yield on your fixed-interest fund. Also, because this yield is considered interest income by the SA Revenue Service, it is subject to income tax ? at a much higher rate than the proposed dividend tax.

Interest rates are falling, so what now?

SA interest rates have fallen by five percentage points since the middle of last year, which means that those investors relying on interest income could be receiving about 40 percent less than they were a year ago.

Most people reliant on income are seeking an inflation-beating yield that exceeds their expenses, thus enabling them to grow their capital. By withdrawing all your interest income each month, however, you will not allow your capital to keep up with inflation.

Article continues on page two...