Portfolio Aim and Criteria
The criteria are organised into three groups: getting a stock onto your radar, deciding when to buy, and deciding when to sell. All buy criteria must be met simultaneously for a buy signal. Any sell criterion triggered is a watch warning; multiple triggers indicate it is time to act.
Understanding Cost of Funds
Before the criteria make sense, you need to understand the concept of Cost of Funds — the single most important input to your Target Income calculation. It answers the question: what does my capital cost me, or what would it earn me, if I did not invest it in shares?
There are three common situations for Australian investors:
- If you have a variable rate home loan, your Cost of Funds is simply your mortgage interest rate. Every dollar you invest in shares is either borrowed at that rate, or is capital that could be repaying your mortgage — either way, the investment must beat that rate to be worthwhile. Current example: RBA Cash Rate 4.10% + home loan margin 1.69% = Cost of Funds 5.79%. Target Income = Cost of Funds + 2.00% buffer = 7.79%.
- The 2% buffer above Cost of Funds is essential — it provides a margin of safety against rate rises, unexpected dividend cuts, and transaction costs. When no qualifying share exists, repaying the home loan at 5.79% pa is itself the investment decision — guaranteed, risk-free and tax-effective.
- If you have no debt, your Cost of Funds is your opportunity cost — what you could reliably earn elsewhere at equivalent or lower risk. For debt-free investors, particularly retirees, this is typically the yield available on a high-yield savings account, a high-quality corporate bond or a term deposit. The principle is the same: if your share portfolio cannot beat the bond yield on a grossed-up basis, you are better off simply holding the bond.
- Example — an AUD corporate bond paying 8.00% pa (ISIN: C2JF080026). A debt-free investor holding such a bond would use 8.00% as their Cost of Funds, giving a Target Income of 10.00% (8% + 2% buffer). Cited here purely to illustrate the opportunity cost concept — not a current recommendation. This particular security matures 31-Dec-2026 and is now difficult to acquire.
- A corporate bond paying 8.00% generates 8.00% — unfranked, taxed at your marginal rate. A fully franked ASX share yielding 7.79% (cash) grosses up to 11.13% — and for investors whose marginal tax rate is at or below the 30% corporate rate, generates a cash franking credit refund on top of the dividend itself. This is the core advantage of Australian dividend investing for resident investors. Franking credits convert a seemingly modest cash yield into a superior after-tax return versus most fixed income alternatives — provided the company consistently pays fully or substantially franked dividends.
- Bonds offer capital certainty (face value returned at maturity) and income certainty (the coupon is fixed). Shares offer neither — price and dividends both fluctuate. The criteria framework manages this uncertainty by requiring both income and capital gain targets to be met before buying, and triggering a sell review when either deteriorates. For a conservative income investor, a blend of franked shares and investment-grade bonds can provide the tax efficiency of franking credits alongside a capital-stable anchor for part of the portfolio.
Portfolio Aim
Always start with your Portfolio Aim — a clear statement of why you are investing and what you want to achieve. Without this, it is easy to make decisions based on emotion, market noise or short-term thinking. Consider using SMART Criteria to make your aim specific, measurable and time-bound. Refine it over time as your circumstances change.
Ask yourself: why am I investing? (income generation, capital growth, preservation of capital) — and what do I hope to achieve? Try to be as specific as possible.
CPI — the Australian Consumer Price Index, published quarterly by the ABS. Used as the minimum real return required to preserve purchasing power. Current CPI: 3.70% pa.
Cost of Funds — the rate at which you borrow money, or your opportunity cost if debt-free. Current: 5.79% pa. See the three cases above for how this is determined.
Once you have your Portfolio Aim, translate it into a concrete set of criteria. These criteria remove emotion from decision-making — you follow them consistently, regardless of market sentiment. It is far better that you decide yourself which criteria to adopt, and then simply follow them.
The criteria in detail
For Australian resident investors, all yield comparisons use grossed-up dividend yield — the cash dividend plus the value of franking credits — to ensure an apples-to-apples comparison between stocks with different franking percentages.
Grossed-up yield = Annual Dividend ÷ (1 − Corporate Tax Rate) ÷ Share Price.
At a 30% corporate tax rate, a fully franked 7.79% dividend yield grosses up to 11.13%. This is what matters for comparison against your Target Income.
Current targets: Target Income 7.79% pa (green) / 7.59% pa (amber) | Grossed-up Target 11.13% pa / 10.84% pa | Target Growth 4.70% pa
- Market capitalisation > $500m (or > $300m if dividend yield is exceptionally strong) Smaller companies carry higher liquidity and governance risk.
- Annual dividend has been consistently above 7.79% pa for at least the last two years Establishes a track record before committing capital.
- On the radar (per A above) Prerequisite — no exceptions.
- PE Ratio < 15 Avoids overpaying for growth expectations that may not materialise.
- EPS (Earnings Per Share) comfortably covers the annual dividend Ensures the dividend is sustainable from operating earnings, not paid out of capital.
- EPS is positive A company paying dividends while reporting a loss is drawing down its capital base.
- Dividend yield > 7.79% pa (raw, unfranked basis) First hurdle — the cash component alone must beat the target.
- Grossed-up dividend yield > 11.13% pa Second hurdle — the full economic return including franking credits must beat the grossed-up target. This is the definitive comparison for Australian resident investors.
- Capital gain percentage ≥ 4.70% pa Buying at a price already showing a meaningful gain from cost ensures you are not overpaying and provides a buffer against a future price fall.
- Wait for the next dividend announcement before buying — do not buy purely in anticipation Historical yields are indicative, not guaranteed. Waiting converts a forecast into a confirmed fact before committing capital.
- Do not buy at IPOs (no dividend track record) The criteria framework requires at least two years of consistent dividend history to establish reliability.
- Dividends have been in the bottom 5 of all currently owned stocks for the last two consecutive years Relative underperformance — the stock is consistently the weakest income contributor.
- Future grossed-up dividend yield has fallen below 11.13% pa The forward income no longer justifies holding this capital versus alternatives, including simply repaying debt at 5.79% pa.
- Capital gain has fallen below 4.70% pa, or is a capital loss Both dimensions of the Portfolio Aim are failing simultaneously — income and growth.
- A qualifying replacement stock exists that would generate higher grossed-up dividends The opportunity cost of holding the underperformer exceeds the transaction costs and CGT implications of switching. This criterion moves a watch situation to an active sell decision.
NHC New Hope Corporation — met sell criteria 13 and 14 simultaneously. Forward grossed-up yield had fallen to 5.77% against a grossed-up target of 11.13% — a gap of 5.36 percentage points. Capital gain was −9.7%. With no qualifying replacement available, capital was returned to the home loan at 5.79% pa — a guaranteed, risk-free return that exceeded NHC’s forward yield entirely.
HVN Harvey Norman — met sell criteria 12 and 13, but criterion 14 is not triggered — Harvey Norman carries a +23% capital gain. With no qualifying replacement available (criterion 15), the correct action is a formal watch list and reassessment at the next reporting season.