The RBA meets today. Almost certainly it will keep the cash rate on hold at just 1.5%.
Economists are divided on the outlook for interest rates. A few say the next move will be up. NAB is predicting another two interest rate cuts from the RBA this year.
I'm not into making predictions. Here's what I do know…
– Inflation remains stubbornly low, running at about 1.5% per annum.
– GDP contracted by 0.5% in the September quarter.
– The Australian dollar remains stubbornly high.
– Household debt is at record highs, running at an eye watering 185% of annual disposable income.
– House prices are through the roof.
– China just raised interest rates, a move designed to slow down its runaway pace of credit growth.
– Just yesterday, Australian retail sales recorded a shock decline in December.
Hardly sounds like a scenario under which the RBA will need to raise interest rates, huh?
Paul Bloxham, chief Australia and New Zealand economist at HSBC, paints an entirely more optimistic picture.
As reported in Business Insider, he expects the pick up in commodity prices and therefore export volumes will feed through to corporate profits, tax revenues, wages growth and inflation. He has the RBA keeping the cash rate on hold at 1.5% through 2017, penciling in hikes for 2018.
So… all savers have to do is wait until 2018 before term deposits rates edge higher. Up from say 2% to 2.25%. On a $100,000 term deposit, that's an extra $250 in your sky rocket in 2018. Put the champagne on ice.
All of which is to say, whatever happens in the coming year to 18 months, interest rates are likely to remain low. Very low.
So what do you do if you want to earn a decent income on your capital?
For me, it's buying dividend-paying shares. Sure, it involves taking a risk, because unlike term deposits, there is a chance you could lose some of your capital. But by diversifying your investments across different companies and sectors, and extending your holding period to three years or more, you can sharply reduce that risk.
The icing on the cake is Australia's generous and almost unique dividend imputation system.
Better known as franking credits, you can use them to reduce your tax liability from all forms of income (not just dividends), with any excess franking credits being refunded to you.
So which companies to buy?
Regular readers will know I'm avoiding the popular banking sector.
Although the big four banks are today trading on attractive fully franked dividend yields, I'm very wary of the downside risk. These are large, slow-growing companies that are highly leveraged to the local property market, and which trade on premium valuations.
A few weeks ago in these pages I highlighted toll road operator Transurban Group (ASX: TCL) as a stock that looked a pretty good bet, particularly as it was trading on a forecast dividend yield of around 5.2%.
Today the company raised its full-year dividend guidance as toll revenue from its Australian and US roads grew 11% to $1,065 million. The Transurban share price has jumped over 5% higher today to $10.95, now up 12% since I highlighted the stock.
Smaller companies can offer even better opportunities for yield hungry investors.
Take Dicker Data Ltd (ASX: DDR) as an example, a recommendation in our Motley Fool Hidden Gems small-cap advisory service.
Despite its share price climbing a massive 45% in the 10 months since our resident small cap expert Claude Walker first tapped the stock as a buy for Motley Fool Hidden Gems members, this wholesale distributor of computer hardware, software, and related products still offers a generous 6.7% fully franked dividend yield.
As part of a diversified portfolio, higher yielding small cap stocks have the potential to power your wealth higher, and faster.
Sure beats the RBA's low interest rates.
