TopYields

Historically, Australian stocks have paid higher dividends than most global stocks. According to 2011 Russell Investments/ASX Long-Term Investing Report, over the past 20 years, Australian equities have outperformed all other asset classes, including real estate, fixed-income instruments and cash. Dividends have accounted for an increasing share of this total return on equities. In fact, according to SSgA Research and FactSet, on a cumulative basis, dividends contributed more than a third of Australian equities' total returns since 1980. Over the past 10 years through December 2011, that proportion has increased to about 45% of Australia's total equity returns. With 10-year government bond yields sitting close to record lows and given the modest growth outlook for the next five years, Australian dividend stocks stand ready to continue their overperformance relative to other asset classes.

Investors should scout through the Australian equity market in pursuit of attractive income plays. In general, the Australian stock market as represented by the All Ordinaries has a trailing dividend yield of around 4.44%. The forward-looking dividend yield is closer to 6.0%. In comparison with the 10-year government bond, the broad stock market's average dividend yield is 110 basis points higher, suggesting that either stocks are cheap or the 10-year government bonds are overvalued.

Yielding more than government bonds, equity income investments based on dividends can also be a way to beat inflation. While fixed-income investments can hardly pay enough to beat inflation, dividend stocks with increasing payouts, assuming all other things stay the same, can secure positive real returns. In fact, according to Credit Suisse Global Investment Returns Yearbook 2011, the long-term growth of dividend stocks in Australia between 1900 and 2010 was 1.1 percentage points higher than the rate of inflation.

Investors should also recognize the fact that dividends paid by Australian companies are worth more than the actual amount of their cash dividend paid. This is so because of a specific tax situation. Given that Australian corporations have already paid taxes on their profits prior to distributions, tax credits known as franking credits are assigned to the dividends these companies pay to their shareholders. Franking credits are a form of dividend imputation aimed at reducing or eliminating the double taxation of dividends. Investors can use franking credits to offset taxes payable on their other income. For franked dividends, there is no withholding tax. For unfranked dividends, a 30% withholding rate would apply, unless there is a more favorable tax treaty arrangement.

Ways to Invest in Dividend-Yielding Equities in Australia

Income investors in the Australian equity market have plenty of options to invest in dividend-yielding securities. One way to benefit from high yields on equities is by investing in exchange-traded funds (ETFs). Two ETFs that offer exposure to Australian dividend-paying equities are Australia-listed Russell High Dividend Australian Shares ETF (ASX: YRDV) and the U.S.-listed WisdomTree Australia Dividend Fund (NYSE Arca: AUSE). The former ETF overweighs financials, and has an annual expense ratio of 0.46% and a distribution yield of 5.5%. The latter ETF has a broader exposure to consumer sectors and financials, and carries an expense ratio of 0.58% and a dividend yield of 4.7%. Below is a table that shows the largest holdings in each of these two dividend ETFs. Most of the holdings are high-yielding dividend stocks.