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How SMSF investors can choose great dividend shares

It’s no secret that self managed super-fund (SMSF) investors can tend to focus on two things when considering a particular share:

  1. Income – Does it pay a dividend, and if so, how much?
  2. Capital preservation – Is it big enough that I don’t have to worry about it going broke anytime soon?

Unfortunately for many investors, this strategy has produced underwhelming returns over the past 12 months. The situation is compounded when you consider it wouldn’t be uncommon for an SMSF portfolio to look something like this:

  • Telstra Corporation Ltd (ASX: TLS)  – down 16.5%
  • Westpac Banking Corp (ASX: WBC) – down 22.6%
  • Woolworths Limited (ASX: WOW) – down 25.4%
  • Commonwealth Bank of Australia (ASX: CBA) – down 20.6%
  • Australia and New Zealand Banking Group (ASX: ANZ) – down 36.3%
  • Wesfarmers Ltd (ASX: WES) – down 5.9%
  • BHP Billiton Limited (ASX: BHP) – down 45.2%
  • Rio Tinto Limited (ASX: RIO) – down 24.5%
  • Woodside Petroleum Limited (ASX: WPL) – down 25.9%

One point to note from the above list of stocks is that many investors were choosing to invest in BHP, Rio Tinto and Woodside based on their huge trailing dividend yields. In hindsight this was obviously a flawed strategy and one which investors can take an important lesson out of.

Resource and energy companies are cyclical in nature and have little control over the price they receive for their products. They are require significant levels of capital expenditure to keep their operations operating smoothly.

It is for these reasons, I believe that investors should never purchase resource companies for their dividends alone. As we have seen this year, during commodity downturns, the focus of these companies becomes preserving cash and this means slashing dividends.

Instead, investors looking for income should focus their search for companies that can consistently pay dividends despite changes in the economic cycle.

Examples of companies that have been able to achieve this include:

Dividends will continue to remain an important part of an SMSF investor’s strategy and over the longer term this has served investors well. In fact, since 2011, dividends have been the biggest contributor to the market’s overall performance, as shown in the chart below.

Source: Google Finance

Source: Google Finance

This chart compares the return of the S&P/ASX 200 (Index: ^AXJO) (ASX:XJO) to the S&P/ASX 200 Net Total Rtn (Index: ^AXNT) (ASX:XNT). Unlike the regular ASX 200 index, the net total return index takes into account cash dividends paid by companies which are then subsequently reinvested on the ex-date of the dividend.

Investors who have remained invested over a longer period of time, have therefore achieved a reasonably attractive level of return especially in comparison to the alternative of being invested in cash.

Foolish takeaway

Although the past 12 months have been difficult for many SMSF investors, the hunt for dividends and income will still remain an important contributor to investment returns over the next few years.

Interest rates are predicted to stay at record lows for an extended period of time and there remains some seriously attractive yield opportunities in the market right now.

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Motley Fool contributor Christopher Georges has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.