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How to pick ASX dividend shares in a low interest rate world

The Reserve Bank of Australia (RBA) is looking likely to cut interest rates again tomorrow, which would mean that our cash rate would be at a new record low of 0.75%. What you would probably know is that this will mean bank savings account and term deposit interest rates will once again take a haircut, pushing returns from these investments to negligible levels.

What you might not realise is that when interest rates are cut, it pushes up the intrinsic value of ASX shares – particularly dividend-paying shares. This occurs because the ‘risk-free rate of return’ that you can achieve from a government bond lowers, making riskier assets like shares more valuable.

So with this in mind, it might be a good idea to consider putting more of your cash in dividend shares as soon as possible – especially considering most economists think that we could see at least one more rate cut by the end of the year.

But not all dividend shares can be considered equal. I generally like to divide them into three camps – bond proxies, ‘generally reliable’ and speculative. Each camp has its own risk profile, so a rate cut should affect the value of the ‘bond proxy’ stocks a lot more than the speculative, based on the reliability of the income you can expect to gain.

Bond proxy dividend stocks are usually considered so reliable in their payouts that they resemble bonds more than shares. Two of the stocks most commonly viewed as bond proxies are Sydney Airport Holdings Pty Ltd (ASX: SYD) and Transurban Group (ASX: TCL).

Transurban owns and operates a network of toll roads across Australia – highly defensive assets with fixed pricing and inflation protections built in. After all, motorists aren’t going to stop driving around Sydney and Melbourne anytime soon.

Ditto with Sydney Airport. This company has a virtual monopoly over NSW skies for commercial and international travel (not to mention airport parking), making its income (and this dividend) extremely stable.

I would place the big ASX banks as well as Woolworths Group Ltd (ASX: WOW) and Wesfarmers Ltd (ASX: WES) in the ‘generally reliable’ category. In a recession, the dividends might take a trim (especially the banks’ payouts) but there’s very little chance of the company going belly-up.

More speculative might be something like Altium Ltd (ASX: ALU) or retailers like Myer Holdings Ltd (ASX: MYR) – which would likely cut their payouts substantially if a recession came along.

Foolish takeaway

Low interest rates mean that we have to pay a premium for safer streams of income from the sharemarket. Choosing dividend shares is now somewhat harder than it used to be, so you will have to weigh up the risks and rewards more carefully when picking dividend stocks going forward and choose the right ones for your personal circumstances.

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Sebastian Bowen has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Altium. The Motley Fool Australia owns shares of and has recommended Sydney Airport Holdings Limited, Transurban Group, and Wesfarmers Limited. 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 Scott Phillips.

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