It may seem strange to be advocating for passive income investing in ASX shares at a time when market commentators are expecting RBA rate rises.
But, given how share prices have drifted lower this year, I'm seeing a great opportunity for investors to grab ASX shares while dividend yields are higher.
Don't forget, we saw a few years ago how some businesses were able to accelerate their revenue growth amid the inflationary period – they were not just helpless bystanders in the situation.
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Why do interest rates matter for ASX shares?
Interest rates play an important role in how much investors are willing to pay for an asset. It acts like gravity – when interest rates go lower, asset prices can jump higher. But, the opposite is typically true when interest rates go up – it's a significant headwind for asset valuations.
But, share prices can still go up in a rising rate environment if the operating profit/net profit of the business or asset increases. The multiple of earnings that investors are willing to pay is just one part of the equation.
Warren Buffett, the legendary American investor from Omaha, once explained why interest rates are so important for valuations. Buffett said:
The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.
Investor expectations of rate rises this year has led to lower share prices for some businesses, along with the oil price volatility.
How does it affect the passive income?
When the share price of an ASX dividend share falls, it can lead to a double whammy of a better valuation and a better dividend yield.
A dividend yield is determined by the size of the payout and the valuation of the business. When share prices go lower, the dividend yield increases.
For example, if a business had a dividend yield of 5% and the share price falls 10%, the dividend yield becomes 5.5%. If it fell 20%, the dividend yield would be 6%.
I like investing at times like these, as it really boosts the potential dividend yield.
Is it a once-in-a-decade opportunity to buy passive income shares? The 2020s have already seen COVID-19, the inflation and tariff related sell-offs, so the declines have been more than once-in-a-decade.
But, this is certainly a rare opportunity to buy ASX dividend shares with a good dividend yield.
What I'd invest in
There are a wide range of ASX dividend shares that are trading at attractive prices with a good dividend yield.
I'm thinking names like Charter Hall Long WALE REIT (ASX: CLW), Centuria Industrial REIT (ASX: CIP), Medibank Private Ltd (ASX: MPL), Telstra Group Ltd (ASX: TLS), Wesfarmers Ltd (ASX: WES), Coles Group Ltd (ASX: COL), Australian Foundation Investment Co Ltd (ASX: AFI), WCM Global Growth Ltd (ASX: WQG), JB Hi-Fi Ltd (ASX: JBH), Universal Store Holdings Ltd (ASX: UNI), Nick Scali Ltd (ASX: NCK) and Lovisa Holdings Ltd (ASX: LOV).
I'm optimistic that the above names can provide investors with a diversified and growing source of passive income over time.
